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CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION SAMPLE MULTIPLE CHOICE QUESTIONS – JUNE 2009 Paper T10 Managing Finances Section A only All questions are compulsory Note: Section B of the actual exam paper will contain four written questions FOR FREE CAT & ACCA RESOURCES VISIT: http://kaka-pakistani.blogspot.com
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15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

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Page 1: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Certified ACCounting teChniCiAn exAminAtion

SAmple multiple ChoiCe queStionS – June 2009

Paper T10 Managing Finances

Section A onlyAll questions are compulsory

Note: Section B of the actual exam paper will contain four written questions

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2

the following questions are typical of those that will appear in Section A of the examination paper from June 2009 onwards. there will be a total of ten questions in section A.

All questions in Section A will be worth two marks each.

1 The following statements have been made about the benefits of debt finance compared to equity finance:

Statement 1: Interest payments on debt attract tax relief. Statement 2: Control of the company is diluted.

Which of the above statements is true?

A Both of them

B Statement 1 only

C Statement 2 only.

d Neither of them. (2 marks)

2 The selling price for a product is $62. It takes 2 hours of skilled labour to make the product and 3 kg of materials. Fixed overheads are $435,000 per annum. The cost of labour is $11 per hour and materials cost $6 per kilogram. Variable overheads are absorbed at the rate of $5 per direct labour hour. The company’s budgeted sales for the product for the next year are 100,000 units.

What is the contribution per unit of the product?

A $12

B $22

C $23

d $17 (2 marks)

3 The break-even sales revenue for a product is $235,000. The selling price of the product is $25 per unit.

if budgeted sales are 10,000 units, what is the margin of safety, in units? A 400

B 10,000

C 9,400

d 600 (2 marks)

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4 Extracts from a company’s accounts show the following balances:

$000 Inventories 114 Trade receivables 216 Cash 42 Trade payables 180 Bank overdraft 60

Which of the following is the company’s quick ratio, calculated to the nearest two decimal places?

A 1.55

B 1.08

C 2.07

d 1.43 (2 marks)

5 The following statements have been made about inflation:

Statement 1: Inflation leads to a distribution of income and wealth. Statement 2: If a country has a higher rate of inflation than its partners, its imports become relatively more expensive

and its exports become relatively cheaper. Which of the above statements is true?

A Both of them

B Statement 1 only

C Statement 2 only

d Neither of them (2 marks)

6 The net present value of a proposed project is $20,000 at a discount rate of 5% and $(28,000) at 10%.

What is the internal rate of return of the project, to the nearest one decimal place?

A 7.1 %

B 7.5 %

C 2.3 %

d 8.6% (2 marks)

7 A company is considering increasing its credit period to customers from one month to two months. Annual revenue is currently $1,200,000. It is expected that the increased credit period would increase sales by 25% and result in an increase in profit of $45,000, before any INCREASE in finance charges have been taken into account. The company’s cost of capital is 10%.

What is the financial effect of this proposal, after taking into account any increase in finances charges?

A Increase in profit of $35,000

B Decrease in profit of $35,000

C Increase in profit of $30,000

d Decrease in profit of $30,000 (2 marks)

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4

8 Which of the following are assumptions used when calculating the economic order quantity for inventory?

(i) lead time is constant (ii) demand is constant (iii) purchase costs are constant

A All three

B i and ii only

C i and iii only

d ii and iii only (2 marks)

9 A company is considering undertaking a contract for a new client. The contract requires 100kg of material A. It has 200kg in inventory, which it bought last year at a cost of $10 per kg. The current resale value is $8, although to replace the material today would cost $15 per kg. There is no other use for the material, except as a substitute for material B, which costs $14 per kg.

What is the relevant price per kg of material A?

A $10

B $14

C $8

d $15 (2 marks)

10 A farmer grows carrots, which he currently digs up and sells in 10kg sacks, without washing the carrots or preparing them in any other way. He is considering whether to trim them, wash them and package them up in 1kg cartons instead of continuing to sell them in sacks.

Which of the following are relevant to his decision?

(i) the cost of growing the carrots (ii) the sales value of the unprepared sacks of carrots (iii) the costs of trimming and washing the carrots (iv) the sales value of the new trimmed cartons of carrots

A All of them

B (i), (iii) & (iv) only

C (ii), (iii) and (iv) only

d (iii) and (iv) only (2 marks)

end of Sample questions

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Answers

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Sample multiple Choice question paper t10 Answersmanaging finance

1 B Only statement 1 is true

2 A Contribution per unit: $ Sales price 62 Labour (2x$11) (22) Materials (3 x $6) (18) Variable overhead(2 x $5) (10) Contribution per unit 12

3 D Break-even sales in units = 235,000/25 = 9,400. Therefore, M of S = 10,000 – 9,400 = 600.

4 A (216 + 42)/(180 + 60) = 1.08, to 2 D.P.s

5 B Only statement 1 is true.

6 A IRR = 5% +

[Distractors:

B IRR = 5% +

C IRR =

D IRR = 5% +

7 D $ Current receivables($1.2/12) 100,000 New receivables ($1.2 x 1.25/6) 250,000 Increase 150,000 Finance cost of increase at 10% 15,000 Net profit increase 45,000

Therefore overall increase is $30,000 ($45,000 – $15,000)

8 A All three are assumptions for EOQ calculations.

9 B The relevant cost is $14 per kg. Since the material has no other use except as a substitute for material B, it would either be used in place of B or sold. As the company would only get $8 per kg from selling it, its best use is as a substitute, therefore saving $14 per kg.

10 C The incremental revenue (iv – ii) should be compared to the incremental costs (iii) of preparing the carrots.

2020 + 28

+ [10% – 5%]⎛

⎝⎜⎞

⎠⎟

2020 – 28

x[10% – 5%]⎛

⎝⎜⎞

⎠⎟

5% +20

20 – 28⎛

⎝⎜⎞

⎠⎟x[10% – 5%]

5% +2028

x]10% – 5%]⎛

⎝⎜⎞

⎠⎟

2020 + 28

+ [10% – 5%]⎛

⎝⎜⎞

⎠⎟

2020 – 28

x[10% – 5%]⎛

⎝⎜⎞

⎠⎟

5% +20

20 – 28⎛

⎝⎜⎞

⎠⎟x[10% – 5%]

5% +2028

x]10% – 5%]⎛

⎝⎜⎞

⎠⎟

2020 + 28

+ [10% – 5%]⎛

⎝⎜⎞

⎠⎟

2020 – 28

x[10% – 5%]⎛

⎝⎜⎞

⎠⎟

5% +20

20 – 28⎛

⎝⎜⎞

⎠⎟x[10% – 5%]

5% +2028

x]10% – 5%]⎛

⎝⎜⎞

⎠⎟

2020 + 28

+ [10% – 5%]⎛

⎝⎜⎞

⎠⎟

2020 – 28

x[10% – 5%]⎛

⎝⎜⎞

⎠⎟

5% +20

20 – 28⎛

⎝⎜⎞

⎠⎟x[10% – 5%]

5% +2028

x]10% – 5%]⎛

⎝⎜⎞

⎠⎟

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Managing Finances

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

ADVANCED LEVEL

WEDNESDAY 16 JUNE 2004

QUESTION PAPER

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered Pape

r T1

0

The Association of Chartered Certified Accountants

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ALL FOUR questions are compulsory and MUST be attempted

1 Paradise Ltd is a large company specialising in luxury holidays for the rich and famous. It has recently purchased anuninhabited island, close to the popular resort of Luca, at a cost of £2 million. The company has already spent £1·5 million on preparing the land for construction work. Over the next year it plans to develop the island extensively,with the aim of making it one of the most exclusive holiday locations in the region.

An offer has just been made to buy the land for £5 million. Paradise Ltd has therefore decided to reappraise the projectin order to decide whether they should still proceed with the project, or should instead accept the offer. If they decideto accept the offer, the sale will take place immediately, incurring legal fees of £20,000. If they reject the offer,development will continue and accommodation will be available for rent in one year’s time.

The company’s project accountant has provided estimates of costs and revenues for the next five years as set outbelow.

1. Total construction costs for the seven hotels on the island are £37 million. Of the total, £2 million has alreadybeen spent in the form of down payments to several construction firms. These down payments are irrecoverable.

2. Total construction costs for the forty luxury self-catering lodges that will be attached to the hotels are £24 million.A down payment of £4 million is required immediately.

3. The cost of furnishing the hotels and lodges is estimated at £3·2 million.

4. Each lodge will have its own private swimming pool. The cost of each pool is expected to be £12,000.

5. Six restaurants will be built on the island at a cost of £15 million. Paradise Ltd has already had to commit to £3 million of these costs in order to attract the chefs it requires. Although these monies have not yet been paidover, Paradise Ltd is contractually bound to pay them, irrespective of whether the project now proceeds.

6. A small parade of shops will be developed at a cost of £4 million.

7. Annual cash overheads are expected to be £2 million for the hotels. Revenues for the hotels are estimated at £13 million per annum.

8. Maintenance costs for each of the lodges will be £7,000 per annum, compared to rental income of £390,000per annum, per lodge.

9. Depreciation totalling £1·5 million per annum will be charged in Paradise Ltd’s accounts for the hotels, lodges,restaurants and shops.

10. The restaurant and shops are expected to generate net income of £4·73 million per annum, in total.

11. Interest on money borrowed to finance the project will be £2·5 million per annum.

All the set-up costs will occur within the next year, before the resort is open. The annual revenues and overheadsrelate to the four years following this. Assume that all cash flows occur at the end of each year, unless otherwisestated, and that there are no terminal values to consider at the end of the four years.

The company’s cost of capital is 10% per annum.

2

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Required:

(a) Explain the main principles used to differentiate between relevant and irrelevant costs for investmentappraisal, using the information in the question to illustrate your points. (8 marks)

(b) Calculate the project’s net present value (NPV) at the company’s required rate of return. Conclude as towhether the company should accept the offer or continue with the project, giving a reason for yourconclusion. (16 marks)

(c) Calculate the internal rate of return (IRR) for the project, using the discount rates in the tables provided.(4 marks)

(d) State three advantages and three disadvantages of using the IRR as a method of project appraisal.(6 marks)

(e) Briefly outline each of the following stages involved in evaluating capital projects:

(i) Initial investigation of the proposal;

(ii) Detailed evaluation;

(iii) Authorisation;

(iv) Implementation;

(v) Project monitoring;

(vi) Post-completion audit. (6 marks)

(40 marks)

(Workings should be in £’000, to the nearest £’000.)

Present Value Table (extract)Discount Rates (r)

Periods (n) 10% 20%1 0·909 0·8332 0·826 0·6943 0·751 0·5794 0·683 0·4825 0·621 0·402

3 [P.T.O.

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This is a blank page.Question 2 begins on page 5.

4

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5 [P.T.O.

2 Chocoholics Ltd sells high quality Belgian chocolates that it buys in ready-made. Its main attraction to customers isthat it gift wraps the items and delivers them to an address of the customer’s choice. The company has just expandedits product range to include flowers.

You are an accounting technician and have been asked to prepare a cash budget for the next six months, incorporatingthe sales of the new products. You have been provided with the following table of estimated revenues and their relativecosts. Other costs are also included in the notes below.

2004 July August September October November December£’000 £’000 £’000 £’000 £’000 £’000

Sales 250 266 282 306 320 330Purchases of chocolates and flowers 125 133 141 153 160 165Administration expenses 155 160 162 165 168 170Packaging costs 112 113 113 113 114 114Miscellaneous expenses 116 116 117 117 118 118Loan repayments 150 – – – 150 –

Notes:1. Opening stocks of chocolates and flowers will amount to £250,000 at 1 July 2004. Closing stocks at

31 December 2004 are estimated at £170,000.2. Suppliers allow one month’s credit. Purchases in June will total £60,000.3. 30% of sales are paid for by cash but the remaining 70% take advantage of the company’s offer of ‘Buy now,

pay in one month’. June 2004 sales are expected to be £140,000.4. Delivery costs are 1% of sales revenue each month, and are paid in the month in which they are incurred.

Administration and miscellaneous expenses are also paid as they are incurred.5. Packaging expenses are paid two months after they are incurred. These costs were £1,000 in May and will be

the same in June.6. The bank charges interest of 1% per month for the overdraft, calculated on the closing bank balance each month,

and payable the following month.7. The bank overdraft at 1 July 2004 is expected to be £155,000.8. The loan repayments above refer to an interest free loan obtained by the company when they moved their

business to a new bank.9. The business has no depreciable fixed assets.

Required:

(a) Prepare a monthly cash budget for EACH of the six months to 31 December 2004, showing the cash balanceat the end of each month. (13 marks)

(b) Prepare a budgeted Profit and Loss account for the six month period ending 31 December 2004.(7 marks)

Note: All workings should be shown clearly in order to score maximum marks. Please show workings in £’000,to the nearest £’000.

(20 marks)

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3 Rant Ltd manufactures and distributes plasma screen televisions to a number of electrical retailers. Due to theincreased popularity of these products, growth has been rapid and the Financial Director (FD) of the company isconcerned that the company is overtrading. Turnover has increased by 250% over the last year, and fixed assets haveincreased by 75%. The bank overdraft limit of £3 million has been exceeded on five occasions in the last year,culminating in a recent threat by the bank to withdraw the facility altogether.

Rant Ltd is a largely family-owned company, with twelve shareholders in total. Whilst the long-term plan involvesmaking a rights issue in two years’ time, none of the current shareholders are in a position to inject new capital intothe company at present. Neither do they wish to issue new shares outside the current group of shareholders, as theydo not want to lose their collective control of the company.

Some preliminary analysis has revealed that debtors are increasing rapidly and raw material stock days have gone upfrom 30 days to 55 days. The FD is concerned that these stock levels are so high. He has asked you, an accountingtechnician, to assist him in reviewing them.

One of the key costs of making a plasma television is the screen. These screens are bought in ready-made at a costof £250 per unit. It costs £150 to place an order for these screens, irrespective of the number of units ordered. Atcurrent sales levels, which are expected to stabilise now, 150,000 screens are needed per annum. The cost of holdingone screen in stock for one year is £15.

Required

(a) Define the terms ‘over-capitalisation’ and ‘overtrading’. (2 marks)

(b) Briefly describe the symptoms of overtrading. Conclude whether Rant Ltd is overtrading, giving reasons foryour conclusion. (6 marks)

(c) Explain the four main types of costs associated with stock management. (4 marks)

(d) Explain how the economic order quantity (EOQ) model can assist in reducing stock costs, AND theassumptions it is based upon. (4 marks)

(e) Calculate the EOQ for screens AND the number of orders to be placed per annum, using the data containedin the question. (4 marks)

(20 marks)

Note: The formula for EOQ is

(where Co represents fixed cost of placing one order;D represents annual demand in terms of units;Ch represents cost of holding one unit of stock per annum.)

2 Co D

Ch

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4 Clean Lens Ltd is a contact lens manufacturer and distributor producing an extensive range of contact lenses that aredistributed direct to customers via the Internet. It is a small company with five shareholders, all of whom are involvedin the running of the company.

The company is in the preliminary stages of developing a new type of contact lens, made of a unique material thatmoulds to the shape of the eye, providing revolutionary comfort for the lens wearer. The company’s projections showthat profits of £1·3 million per annum are expected over the first five years, once sales commence.

In order to proceed with the project, further finance of £1·5 million is required. Clean Lens Ltd expects to fund theproject through a mix of debt and equity finance, and is considering approaching venture capital organisations.

Required:

(a) Briefly explain five factors that Clean Lens Ltd should take into account when deciding on the mix of debtand equity finance. (10 marks)

(b) Identify and discuss five factors that a venture capital organisation should take into account when decidingwhether or not to invest in Clean Lens Ltd. (10 marks)

(20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2004 Answers

1 (a) Relevant costsThe following principles should be applied when identifying costs that are relevant to a period.

Relevant costs are future costsA relevant cost is a future cost arising as a direct consequence of a decision. A cost which has been incurred in the past istherefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’.

In Paradise Ltd’s project, the £1·5 million spent preparing the land for construction is a sunk cost, as is the £2 million down-payment to construction firms. These costs should therefore be excluded when calculating the net present value of the project.

Relevant costs are cash flowsOnly those future costs which are in the form of cash should be included. This is because relevant costing works on theassumption that profits earn cash.

Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making. This means thatthe depreciation charges of £1·5 million should be ignored in the decision for Paradise Ltd.

Relevant costs are incremental costsA relevant cost is the increase in costs which results from making a particular decision. Any costs or benefits arising as aresult of a past decision should be ignored.

Opportunity costsAn opportunity cost is the value of a benefit foregone as a result of choosing a particular course of action. Such a cost willalways be a relevant cost.

Other non-relevant costsCertain other costs will be irrelevant to decision-making, such as ‘committed costs’. A committed cost is a future cash outflowthat will be incurred anyway, regardless of what decision will now be taken. The £3 million restaurant costs represent suchcommitted costs, and these will therefore be ignored for the decision-making process.

The interest costs of £2·5 million per annum are also ignored. This is not because they do not meet the above criteria, butbecause they are taken into account in the discounting process. If these costs were included as relevant they would be doublecounted.

(b) Net present valueYears

0 1 2 3 4 5 Total£’000 £’000 £’000 £’000 £’000 £’000 £’000

Net sale proceeds foregone (4,980) (4,980)Hotel building costs (35,000) (35,000)Lodge building costs (4,000) (20,000) (24,000)Furnishings (3,200) (3,200)Swimming pools (480) (480)Restaurants (12,000) (12,000)Shops (4,000) (4,000)Annual overheads – hotel (2,000) (2,000) (2,000) (2,000) (8,000)Annual revenues – hotel 13,000 13,000 13,000 13,000 52,000Rentals – lodges 15,600 15,600 15,600 15,600 62,400Lodge overheads (280) (280) (280) (280) (1,120)Restaurant/shop income 4,730 4,730 4,730 4,730 18,920

––––––– -–––––– ––––––– ––––––– ––––––– ––––––– –––––––Net relevant costs (8,980) (74,680) 31,050 31,050 31,050 31,050 40,54010% discount factors 1·000 0·909 0·826 0·751 0·683 0·621

––––––– -–––––– ––––––– ––––––– ––––––– ––––––– –––––––Discounted cash flow (8,980) (67,884) 25,647 23,319 21,207 19,282 12,591

––––––– -–––––– ––––––– ––––––– ––––––– ––––––– –––––––

Since the net present value of the project is positive at £12·591 million, the company should proceed with it.

(Note: An alternative NPV calculation is shown overleaf, using an annuity factor. Where workings are shown clearly for the‘net cash flow’ figures, full marks should be awarded for this method.)

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Alternative presentation for 1(b)Years Net cash flow DF/AF Present value

£’000 £’0000 (8,980) 1·000 (8,980)1 (74,680) 0·909 (67,884)

2–5** 31,050 2·881 89,455––––––––

12,591––––––––

**Annuity factor for T2 – 5 = 0·826 + 0·751 + 0·683 + 0·621.

(c) Internal rate of returna

––––IRR = A + [a – b

x (B–A) ]

Where A is the lower rate and B is the higher rate; a is the NPV at the lower rate and b is the NPV at the higher rate.

(In this case, 20% has been used as the higher rate.)

10% +12·591

x (10%)––––––16·805

= 17%––––

WorkingYears

0 1 2 3 4 5 Total£’000 £’000 £’000 £’000 £’000 £’000 £’000

Net relevant costs (8,980) (74,680) 31,050 31,050 31,050 31,050 40,54020% discount factors 1·000 0·833 0·694 0·579 0·482 0·402

–––––– –––––– –––––– –––––– –––––– –––––– ––––––Discounted cash flow (8,980) (62,208) 21,549 17,978 14,966 12,482 (4,214)

–––––– –––––– –––––– –––––– –––––– –––––– ––––––Net present value at 20% = – £4·214 million

(d) Advantages and disadvantages of IRRAdvantages include:1. It takes into account the time value of money, which is a good basis for decision-making.2. Results are expressed as a simple percentage, and are more easily understood than some other methods.3. It indicates how sensitive decisions are to a change in interest rates.

Disadvantages include:1. Projects with unconventional cash flows can have either negative or multiple IRRs. This can be confusing to the user.2. IRR can be confused with ARR or ROCE, since all methods give answers in percentage terms. Hence, a cash-based

method can be confused with a profit-based method.3. It may give conflicting recommendations to NPV.4. Some managers are unfamiliar with the IRR method.

Note: Only 3 advantages and 3 disadvantages were required.

(e) The stages for project appraisal(i) Initial investigation of the proposal

Firstly, a decision must be made as to whether the project is technically feasible and commercially viable. This involvesassessing the risks and deciding whether the project is in line with the company’s long-term strategic objectives.

(ii) Detailed evaluationA detailed investigation will take place in order to examine the projected cash flows of the project. Sensitivity analysis isperformed and sources of finance will be considered.

(iii) AuthorisationFor significant projects, authorisation must be sought from the company’s senior management and Board of Directors.This will only take place once such persons are satisfied that a detailed evaluation has been carried out, that the projectwill contribute to profitability and that the project is consistent with the company strategy.

(iv) ImplementationAt this stage, responsibility for the project is assigned to a project manager or other responsible person. The resourceswill be made available for implementation and specific targets will be set.

(v) Project monitoringNow the project has started, progress must be monitored and senior management must be kept informed of progress.Costs and benefits may have to be re-assessed if unforeseen events occur.

(vi) Post-completion auditAt the end of the project, an audit will be carried out so that lessons can be learned to help future project planning.

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2 (a) Cash budget for the six months ended 31 December 2004July August September October November December Total

£’000 £’000 £’000 £’000 £’000 £’000Cash inflowsSales receipts 173 255 271 289 310 323 1,621

–––– –––– –––– –––– –––– –––– –––––173 255 271 289 310 323 1,621–––– –––– –––– –––– –––– –––– –––––

Cash outflowsPayments to suppliers 160 125 133 141 153 160 1,772Admin. expenses 155 160 162 165 168 170 1,380Delivery costs 113 113 113 113 113 113 1,118Packaging 1v1 111 112 113 113 113 1,113Misc. expenses 116 116 117 117 118 1v8 1,142Loan repayments 150 150 1,100Overdraft interest 112 112 111 11 1,115

–––– –––– –––– –––– –––– –––– –––––177 197 208 219 285 244 1,330–––– –––– –––– –––– –––– –––– –––––

Net cash flow 11(4) 158 163 170 125 179 1,291Opening balance (155) (159) (101) 1(38) 132 157 1,(155)

–––– –––– –––– –––– –––– –––– –––––Closing balance (159) (101) 1(38) 132 157 136 1,136

–––– –––– –––– –––– –––– –––– –––––

Workings1. Sales receipts

July August September October November December£’000 £’000 £’000 £’000 £’000 £’000

Cash: 30% x £250 75Credit: 70% x £140 98

––––173––––

Cash: 30% x £266 80Credit 70% x £250 175

––––255––––

Cash: 30% x £282 85Credit: 70% x £266 186

––––271––––

Cash: 30% x £306 92Credit: 70% x £282 197

––––289––––

Cash: 30% x £320 96Credit: 70% x £306 214

––––310––––

Cash: 30% x £330 99Credit: 70% x £320 224

––––323––––

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14

(b) Budgeted Profit and Loss Account for the six months ending 31 December 2004

£’000 £’000Sales (w.1) 1,754Less cost of sales (w.2) (976)

–––––Gross profit 778Delivery costs (w.3) 18Administration expenses (w.4) 380Miscellaneous expenses (w.5) 42Interest (w.6) 3

––––(443)

–––––Net profit 335

–––––

Workings £’0001. Sales:

––––––(£250,000 + £266,000 + £282,000 + £306,000 + £320,000 + £330,000) 1,754

––––––

2. Cost of sales £’000Opening stock 250Purchases 877(£125,000 + £133,000 + £141,000 + £153,000 + £160,000 + £165,000)Closing stock (170)

–––––957

Packaging 19(£2,000 + £3,000 + £3,000 + £3,000 + £4,000 + £4,000)

–––––Total 976

–––––

£’0003. Delivery costs

–––––(£3,000 + £3,000 + £3,000 + £3,000 + £3,000 + £3,000) 18

–––––Note: Delivery costs could have been included in COS.

4. Administration expenses–––––

(£55,000 + £60,000 + £62,000 + £65,000 + £68,000 + £70,000) 380–––––

5. Miscellaneous expenses–––––

(£6,000 + £6,000 + £7,000 + £7,000 + £8,000 + £8,000) 42––––––––––

6. Interest (£2,000 + £1,000) 3–––––

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15

3 (a) Definitions‘Over-capitalisation’ means that there is an excessive amount of the business’ money invested in assets.

‘Overtrading’ means that a business’ volume of trade is too large given the level of long-term capital at its disposal.

(b) Symptoms of OvertradingThe symptoms of overtrading are as follows:– A rapid increase in turnover.– A rapid increase in the volume of current assets, and sometimes fixed assets.– A rapid increase in trade creditors and the bank overdraft, with very little increase in equity capital (if any).– A significant reduction in liquidity ratios and an increase in debt ratios.

Conclusion for Rant LtdThe first two of these symptoms are present for Rant Ltd, as turnover has increased by 250% and fixed assets have increasedby 75%.

In addition, the bank overdraft limit has been exceeded on five occasions, suggesting that there has been a rapid increase inbank borrowing. We are also told that current shareholders cannot afford further shares at present, nor do they want newshares to be issued to new shareholders, so the implication is that there has been no injection of additional equity financerecently.

Finally, whilst we cannot calculate debt and liquidity ratios from the information, we can deduce, from the information given,that they will have increased and decreased respectively.

We can therefore conclude that Rant Ltd is overtrading.

(c) Stock costsThe four main stock costs are as follows:

Holding costsThe cost of holding stocks includes the following:– Finance cost, since capital is tied up in stocks– Warehouse and handling costs– Deterioration costs– Obsolescence costs– Insurance costs– Pilferage costs.

Ordering costsThere will be costs for Rant Ltd when placing orders with manufacturers. Such costs will include delivery costs, and also theadministrative costs involved in placing order (staff costs, telephone charges, etc.)

Shortage costsThese may include:– Loss of a sale, and the consequent loss of contribution that would have been earned from that sale.– Additional costs involved in making emergency orders for goods.– The costs of lost production, when stock-outs occur and production lines grind to a halt. Staff will still have to be paid,

even if they have no work to do.

Stock costsThe actual cost of the raw materials from the manufacturers (or goods for resale from the wholesalers).

(d) Rationale and assumptionsThe economic order quantity (EOQ) model is used to decide the optimum order size for stocks. This then minimises the totalof ordering costs and stockholding costs.

AssumptionsIt is based on the following assumptions:– demand is constant– the lead time is constant or zero (suppliers are reliable)– purchase costs per unit are constant (i.e. no bulk discounts)

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16

(e) EOQ calculationThe EOQ for Rant Ltd is calculated as follows:

=

=

= 1,732.

The number of orders to be placed will therefore be 150,000/1,732

= 86 per annum.

4 (a) Debt vs equityFactors that should be taken into account when deciding the mix of debt and equity finance are as follows:

(i) CostThe higher the cost of funding, the lower the company’s profit. Equity funding is more expensive as an equity investoris subject to both business and finance risk. The investor will therefore demand a higher return for his increased levelof risk.

(ii) TaxationThe tax treatment of the cost of financing needs to be taken into account. Interest on debt is tax deductible, whereas ifequity finance is raised, dividends paid to shareholders will not be tax deductible. This fact, combined with the lowerrisk of debt financing, means that debt tends to be cheaper.

(iii) Control of the businessIf finance is raised through the issue of shares to new shareholders, those shareholders become joint owners of thebusiness. The percentage of shares held by existing shareholders will therefore decrease. As this percentage decreases,so does the individual shareholders’ voting power.

When deciding on the number of shares to be issued, the current shareholders will probably want to retain their votingcontrol. This should therefore be considered when deciding the mix of debt and equity.

(iv) The effect on gearingGearing measures the amount of debt compared to the amount of equity. If too much debt is issued, Clean Lens Ltd’sgearing ratio will increase. Finance providers will then see the company as a high-risk investment, and will expect higherreturns to compensate for their increased risk. This may lead to unwillingness, on the part of finance providers, to lendmoney to Clean Lens Ltd at all.

(v) Current level of debt and maturity of existing borrowingsA significant difference between debt and equity finance is that debt has to be repaid, but equity does not. If Clean LensLtd already has substantial debt finance, then they will already be making repayments, or they will be committed tomaking repayments in the future.

Therefore, when considering the mix of further debt and equity finance, they should ensure that they do not over-committhemselves to future loan repayments.

(vi) Availability of financeAs Clean Lens Ltd is a private limited company, the availability of equity financiers may be limited. This will, to a certainextent, dictate the mix of debt and equity finance.

NOTE: Only five factors were required.

2 Co D

Ch

2 £ 1 ,000£ 5

× ×150 501

3 000 000, ,

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17

(b) Venture capitalFactors that a venture capital organisation will take into account are as follows:

(i) Level of expertise of the company’s managementVenture capitalists will believe that the success of Clean Lens Ltd is highly dependent on the quality of the company’smanagement team. They will expect Clean Lens Ltd to have a skilled team, who are experienced managers.Management will also be required to show a high level of commitment to the project, and the company. As the ownersof the business are all involved in the running of the company, this should be proof of their commitment.

(ii) Level of expertise in productionThe venture capitalists will seek assurance that the company has the necessary technical ability to be able to developand produce the new contact lenses. They will want evidence that the management and staff are technically competent.

(iii) The nature of Clean Lens Ltd’s new productThe venture capitalists will consider whether the development and production of the new lens is technically feasible.They will employ experts in the field to examine the idea and assess whether the new lens will actually providerevolutionary comfort.

(iv) The market and competitionThey will seek assurance that there is actually a market for a new contact lens, as there are already so many differentproducts on the market. They will ask to see any market research that the company has carried out. The venturecapitalists will also look at the threat posed by new entrants in the contact lens market, and current rival producers.

(v) Future prospectsSince the risk involved in investing capital in the company is fairly high, the venture capitalists will seek to ensure thatthe prospects for future profits compensate for the risk. They will therefore want to see a detailed business plan settingout the future business strategy. Clean Lens Ltd has already prepared profit projections showing a very good margin onthe product.

(vi) Risk borne by current owners of Cleans Lens LtdThe venture capitalists will expect to see that the current owners bear a high degree of risk. This will give them assurancethat the owners have the sufficient level of commitment to the company, as they themselves will have a lot to lose shouldthe company fail. As there are only five shareholders, it is likely that each of them has invested a significant amount ofmoney.

(vii) Exit routeThe venture capitalists will try to establish a number of exit routes. These may include a sale of shares to the public,following a flotation, a sale of shares to another business, or a sale of shares to the original owners.

(viii) Board membershipSince the venture capitalists will want to ensure that their investment is protected, they will required a place on the Boardof Directors. This will enable them to have their say on all significant matters affecting the business.

NOTE: Only five factors were required.

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2004 Marking Scheme

Marks1 (a) Relevant cashflows

RC = future cash flow 1Not sunk costs 1£1·5m and £2m = sunk cost 1RC = form of cash 1Ignore depreciation 1RC arises as result of decision 1Committed cost of £3m – ignore 1Interest costs ignored 1

––––8

––––(b) NPV calculations

Opportunity cost 1Hotel building costs of £35k T1 1Lodge costs £4k T0 1Lodge costs £20k T1 1Furnishings/Swimming pools T1 1Restaurants T1 1Shops T1 1Annual overheads hotel T2–5 1Annual revenues hotel T2–5 1Annual rentals lodges T2–5 1Annual overheads lodges T2–5 1Restaurant and shop profits T2–5 1Net relevant cost totals 1Correct 10% DFs 1Correct discounted CFs 1Correct conclusion 1

––––16

––––(c) IRR calculation

IRR calculation 2NPV calculations 2

––––4

––––(d) IRR ads and disads

Each advantage 1Each disadvantage 1

––––6

––––(e) Six stages

Each stage 1––––

Total 6––––

Total marks available 40––––

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Marks2 (a) Cash flow forecast

Sales receipts 3Purchases 1Admin expenses 1Delivery costs 1Packaging 1Miscellaneous expenses 1Loan repayments 1Overdraft interest 1Net cash flow 1Opening balance 1Closing balance 1

––––13

––––(b) Profit and loss account

Sales 1COS 3Admin. and misc. expenses 1Recalculating interest 1Deriving net profit 1

––––7

––––Total marks available 20

––––

3 (a) DefinitionEach definition 1

––––2

––––(b) Overtrading

Symptoms 2Conclusion and reasons 4

––––6

––––(c) Stock costs

Each cost explained 1––––

4––––

(d) EOQ modelExplanation of model 1Each assumption 1

––––4

––––(e) Calculations

EOQ calculation 3Number of orders 1

––––4

––––Total marks available 20

––––

4 (a) Debt and equityFor each factor explained 2

––––10

––––(b) Venture capital

For each factor identified and discussed 2––––10

––––Total marks available 20

––––

20

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Managing Finances

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

ADVANCED LEVEL

WEDNESDAY 15 DECEMBER 2004

QUESTION PAPER

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examinationhall

The Association of Chartered Certified Accountants

Pape

r T1

0

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ALL FOUR questions are compulsory and MUST be attempted

1 Tots Ltd specialises in the importation and sale of equipment for children’s indoor play centres. The company was setup two years ago by its joint shareholders, Mr and Mrs Brute.

The business has been very successful, expanding rapidly over the last year, and the cash balance in the company’scurrent account has exceeded £1 million on several occasions recently.

Mr and Mrs Brute have asked you, an accounting technician for Tots Ltd, to assist them in managing their cashbalances over the next six months.

You have been provided with the following information.

(i) The bank balance on 1 January 2005 is forecast at £1·2 million in credit.(ii) Sales for November and December 2004 are £1·3 million per month. They are expected to rise to £1·5 million

in January 2005, £1·7 million in February and £1·9 million in March. They will then fall to £1·4 million foreach of the following six months. This is due to a downturn in demand as the weather improves.

(iii) All sales are made on credit. 2% of debtors do not pay at all, 70% pay one month after sale and the remaining28% pay two months after sale.

(iv) Purchases are made one month prior to sales, and two months’ credit is taken from suppliers. (v) The company’s gross profit margin is 50%.(vi) The cost of employing Tots Ltd’s permanent staff is £150,000 per month. Tots Ltd also employs temporary staff

during January, February and March at an additional cost equating to 3% of sales each month.(vii) Tots Ltd uses a courier to despatch the equipment to its customers. The cost of this service is 2% of sales value

in January to March, falling to 1% thereafter. (viii) Administration costs are forecast at £30,000 for January. These costs are directly proportional to sales each

month.(ix) Mr and Mrs Brute will be attending a conference abroad in July 2005 at a total cost of £5,000. They must

complete the booking form and send it off, along with a deposit of £2,000, by the end of January 2005. Thefinal balance is due in June.

(x) The company charges depreciation of £45,000 each month.(xi) Tots Ltd also owns two indoor play centres that it rents out at the rate of £3,500 each per month from January

to April, falling to £3,000 per month thereafter. All rents are received one month in advance.(xii) The company will invest in a new computer system later in the year. This will be paid for by two equal

instalments of £200,000, one in June and one in September.

Required:

(a) Prepare a monthly cash budget for EACH of the six months to 30 June 2005, showing clearly any necessaryworkings.

NOTE: All workings should be in £000.Unless told otherwise, assume that payments are made in the month in which the costs are incurred.

(16 marks)

Mr and Mrs Brute are aware that the business is holding too much cash, but are unsure how to invest it safely. Theyare very risk averse, having each lost a considerable amount of money on the Stock Exchange. They also want toensure that they retain enough cash to allow the business to meet its debts as they fall due.

(b) Briefly explain three motives for holding cash, as identified by Keynes. (6 marks)

2

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(c) Define and explain the characteristics of THREE out of the four types of investment below. In light of thecharacteristics you have identified, conclude as to whether you consider each of the investments you haveexplained to be an appropriate use of Tots Ltd’s cash surplus.

(i) Certificates of deposit;(ii) Gilt-edged securities (gilts);(iii) Shares;(iv) Bills of exchange. (18 marks)

Note: Each type of investment carries equal marks.

(40 marks)

3 [P.T.O.

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2 Pooch Ltd makes and sells pet care products. The following projected data for the next year is available.

Sales £2,200,000

Costs as percentage of salesRaw materials 15%Direct labour 20%Variable production overheads 11%Fixed production overheads 10%Other costs 12%

Working capital statisticsAverage raw material holding period 4 weeksAverage Work-in-progress (WIP) holding period 2 weeksAverage finished goods holding period 4 weeksAverage debtors’ collection period 6 weeksAverage creditors’ payment period on:Raw materials 4 weeksDirect labour 1 weekVariable production overheads 8 weeksFixed production overheads 5 weeksOther costs 12 weeks

Other relevant information– All finished goods stock and WIP values include raw materials, direct labour, variable production overheads and

apportioned fixed production overhead costs.

– Assume WIP is 75% complete as to materials and 50% complete as to direct labour, variable productionoverheads and fixed production overheads.

– Assume there are 52 weeks in one year.

– Assume that production and sales volumes are the same.

Required:

(a) Calculate the estimated average working capital required by Pooch Ltd for the year, showing clearly allnecessary workings.

NOTE: All workings should be in £.(14 marks)

(b) Pooch Ltd is currently in dispute with one of its suppliers, Petcoats Ltd. Pooch Ltd is unsure of its legalobligations regarding an agreement it made with Petcoats Ltd. The Financial Director of Pooch Ltd has askedyou, an accounting technician, to explain certain legal terms to him.

Define and briefly explain the following legal terms:

(i) ‘Offer’; (2 marks)

(ii) ‘Acceptance’; (2 marks)

(iii) ‘Consideration’. (2 marks)

(20 marks)

4

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This is a blank pageQuestion 3 begins on page 6

5 [P.T.O.

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3 Taxi Ltd is a long established company providing high quality transport for customers. It currently owns and runs 350cars and has a turnover of £10 million per annum.

The current system for allocating jobs to drivers is very inefficient. Taxi Ltd is considering the implementation of a newcomputerised tracking system called ‘Kwictrac’. This will make the allocation of jobs far more efficient.

You are an accounting technician for an accounting firm advising Taxi Ltd. You have been asked to perform somecalculations to help Taxi Ltd decide whether Kwictrac should be implemented. The project is being appraised over fiveyears.

The costs and benefits of the new system are set out below.

(i) The central tracking system costs £2,100,000 to implement. This amount will be payable in three equalinstalments: one immediately, the second in one year’s time, and the third in two years’ time.

(ii) Depreciation on the new system will be provided at £420,000 per annum.

(iii) Staff will need to be trained how to use the new system. This will cost Taxi Ltd £425,000 in the first year.

(iv) If Kwictrac is implemented, revenues will rise to an estimated £11 million this year, thereafter increasing by 5%per annum (i.e. compounded). Even if Kwictrac is not implemented, revenues will increase by an estimated£200,000 per annum, from their current level of £10 million per annum.

(v) Despite increased revenues, Kwictrac will still make overall savings in terms of vehicle running costs. These costsavings are estimated at 1% of the post Kwictrac revenues each year (i.e. the £11 million revenue, rising by 5%thereafter, as referred to in note (iv)).

(vi) Six new staff operatives will be recruited to manage the Kwictrac system. Their wages will cost the company£120,000 per annum in the first year, £200,000 in the second year, thereafter increasing by 5% per annum(i.e. compounded).

(vii) Taxi Ltd will have to take out a maintenance contract for the Kwictrac system. This will cost £75,000 per annum.

(viii) Interest on money borrowed to finance the project will cost £150,000 per annum.

(ix) Taxi Ltd’s cost of capital is 10% per annum.

Required:

(a) Calculate the net present value of the new Kwictrac project to the nearest £000. Use the discount factorsprovided at the end of the question. (10 marks)

(b) Calculate the simple payback period for the project and interpret the result. (3 marks)

(c) Calculate the discounted payback period for the project and interpret the result. (3 marks)

6

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(d) Taxi Ltd wants to ensure that it has enough cash available to pay the second and third instalments for theKwictrac system, when they fall due. The company has therefore decided to invest the cash on time depositswith its local bank. The rates of interest paid by the bank are as follows:

6 month deposits 7% per annumOne year deposits 8% per annumTwo year deposits 9% per annumThree year deposits 10% per annum

Interest is paid once a year, at the end of the year.

Calculate the total amount of cash that Taxi Ltd needs to put on deposit immediately in order to meet thefinal two instalments for Kwictrac. (4 marks)

NOTE: You should assume that all cash flows occur at the end of the year, unless otherwise stated.

Present Value table (extract)

Periods (n) Discount rate (r)10%

1 0·9092 0·8263 0·7514 0·6835 0·621

(20 marks)

4 Skint Ltd is a small family owned company that makes fuses for electrical plugs. It was set up twenty-five years agoby its main shareholder, Mr Holmes, who is also the Managing Director of the company.

The company is facing short-term cash flow difficulties. It is already a highly geared company and Mr Holmes isconcerned that the bank will not lend it any more money. He is considering applying for a personal loan or giving apersonal guarantee in order to solve the company’s short-term cash flow difficulties.

Required:

(a) List and explain the general factors that will be taken into account by a bank when deciding whether or notto lend money to a client. (14 marks)

(b) Briefly explain three characteristics that any security for a loan should have. (3 marks)

(c) Briefly describe the following:

(i) bullet repayment loan;(ii) balloon repayment loan;(iii) amortising loan (straight repayment loan). (3 marks)

(20 marks)

End of Question Paper

7

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2004 Answers

1 – Tots Ltd

(a) Cash BudgetNote Jan Feb Mar Apr May Jun Total

£000 £000 £000 £000 £000 £000 £000Cash inflowsSales 1 1,274 1,414 1,610 1,806 1,512 1,372 8,988Rental income 2 7 7 7 6 6 6 39

–––––– –––––– –––––– –––––– –––––– –––––– ––––––1,281 1,421 1,617 1,812 1,518 1,378 9,027

–––––– –––––– –––––– –––––– –––––– –––––– ––––––Cash outflowsPurchases 3 650 750 850 950 700 700 4,600Permanent staff 150 150 150 150 150 150 900Temporary staff 4 45 51 57 0 0 0 153Delivery 5 30 34 38 14 14 14 144Administration 6 30 34 38 28 28 28 186Conference 2 3 5Computer system 200 200Depreciation – ignore

–––––– –––––– –––––– –––––– –––––– –––––– ––––––907 1,019 1,133 1,142 892 1,095 6,188

–––––– –––––– –––––– –––––– –––––– –––––– ––––––Net cash flow 374 402 484 670 626 283 2,839Opening balance 1,200 1,574 1,976 2,460 3,130 3,756 1,200

–––––– –––––– –––––– –––––– –––––– –––––– ––––––Closing balance 1,574 1,976 2,460 3,130 3,756 4,039 4,039

–––––– –––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– –––––– ––––––

(The total column is a useful arithmetic check but not specifically required by the question.)

Notes1. Sales Nov Dec Jan Feb Mar Apr May Jun

£000 £000 £000 £000 £000 £000 £000 £000Sales volumePer the question 1,300 1,300 1,500 1,700 1,900 1,400 1,400 1,400Sales receipts70% paid in 1 month n/a n/a 910 1,050 1,190 1,330 980 98028% paid in 2 months n/a n/a 364 364 420 476 532 392

–––––– –––––– –––––– –––––– –––––– ––––––1,274 1,414 1,610 1,806 1,512 1,372

–––––– –––––– –––––– –––––– –––––– ––––––

2. Rental income Jan Feb Mar Apr May Jun Jul£000 £000 £000 £000 £000 £000 £000

Play Centre 1 and 2(2 x £3,000/£3,500) 7 7 7 7 6 6 6

––– ––– ––– ––– ––– –––Received one month in advance 7 7 7 6 6 6

––– ––– ––– ––– ––– –––7 7 7 6 6 6

––– ––– ––– ––– ––– –––

3. PurchasesOrders are made each month for the following month’s requirements, but 60 days credit is taken.This means that the company is paying for the previous month’s purchase requirements each month.

Dec Jan Feb Mar Apr May Jun£000 £000 £000 £000 £000 £000 £000

Sales volumePer the question 1,300 1,500 1,700 1,900 1,400 1,400 1,400Purchase requirements at 50% 650 750 850 950 700 700 700

–––––– –––––– –––––– –––––– –––––– ––––––Payments to suppliers n/a 650 750 850 950 700 700

–––––– –––––– –––––– –––––– –––––– ––––––

4. Temporary staff (Jan to March only)

Jan Feb Mar£000 £000 £000

Sales levels 1,500 1,700 1,900–––––– –––––– ––––––

Temp costs at 3% 45 51 57–––––– –––––– ––––––

11

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12

5. Delivery costs Jan Feb Mar Apr May Jun£000 £000 £000 £000 £000 £000

Sales levels 1,500 1,700 1,900 1,400 1,400 1,400–––––– –––––– ––––––

Delivery costs at 2% 30 34 38–––––– –––––– –––––– –––––– –––––– ––––––

Delivery costs at 1% 14 14 14–––––– –––––– ––––––

6. Administration costsPer the question, these costs are directly proportionate to sales.£30,000/£1,500,000 = 2%, therefore calculate these costs as 2% of sales each month.

Jan Feb Mar Apr May Jun£000 £000 £000 £000 £000 £000

Sales levels 1,500 1,700 1,900 1,400 1,400 1,400–––––– –––––– –––––– –––––– –––––– ––––––

Admin costs at 2% 30 34 38 28 28 28–––––– –––––– –––––– –––––– –––––– ––––––

(b) Motives for holding cash

The three motives for holding cash, as identified by Keynes, are:

(i) The transactions motive. This means that a business holds cash in order to make the payments that are necessary tokeep the business going, such as wages, taxes and payments to suppliers. If the business cannot meet its financialobligations as they arise, it may cease to be a going concern. It is therefore the main motive for holding cash.

(ii) The precautionary motive. The second motive for holding cash is so that the business does not find itself in financialdifficulties should some unforseen expenses arise. In practice, businesses tend to cover themselves against this byarranging overdraft facilitities with their banks. These do not cost businesses anything unless they are used.

(iii) The speculative motive. This refers to businesses holding cash in case an opportunity to invest and earn money arises.Few businesses are likely to do this in practice as they will lose money whilst waiting for an opportunity to arise.

(c) Possible investments

(i) Certificates of deposit (CDs)

These are negotiable instruments in bearer form. Title belongs to the holder and can be transferred by delivering thecertificate to the buyer.

Bank and Building Societies issue these CDs, which will state on them the amount of the deposit and the date ofrepayment. The deposit amount will usually be at least £100,000 and the repayment date will be anything from oneweek to five years.

Repayment is obtained by presenting the CD to the issuer on the designated date. Alternatively, since CDs are negotiable,they can be sold at any time by the holder.

CDs usually offer an attractive rate of interest and a low credit risk. They are useful for investing funds in the short termsince they can be sold at any time on the secondary market.

Since Tots Ltd has a large amount of cash available over a long period, it does not need instant access to all its cash.It may therefore earn more interest from a money market time deposit, for example, rather than a CD.

(ii) Gilt-edged securities (gilts)

These are marketable British Government securities. The government issues them to finance its spending, but also usesthem to control the money supply. Most gilts have a face value of £100 at which the government promises to buy thegilt back on a specific date in the future.

Gilts usually have fixed interest rates, although there are also various index-linked gilts. Where they are the index-linkedtype, both the interest and the redemption value are linked to inflation, ensuring that a decent real return is gained.

Gilts may be ‘Shorts’ (repaid in less than five years), ‘Mediums’ (repaid in five to fifteen years), or ‘Longs’ (repaid in morethan fifteen years). Some of the older gilts, such as 31/2% War Loans, are irredeemable.

If you buy a gilt and hold it until it is repaid by the government, the return you get will be fixed from the outset. As thegovernment will not default on the debt and the interest to be earned is known in advance, this makes it a low riskinvestment.

Gilts are also traded on the stock market, however, where their price can go up or down, depending on what peoplethink will happen with interest rates. When interest rates are expected to fall, the price of the gilt rises, and when interestrates are expected to rise, the gilt price falls. Using gilts in this way makes them a more risky investment, but stillrelatively safe when compared with buying shares on the stock exchange.

Gilts are transferrable on the secondary market in multiples of a penny, but if they are bought from new the minimuminvestment is £1,000. There is no maximum investment limit. They are easy to transfer and title can even be passedelectronically now.

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Given that the Brutes are very risk averse when it comes to investing surplus funds, gilts would be a good choice ofinvestment for Tots Ltd.

(iii) Shares

There are two main types of shares – ‘ordinary shares’ and ‘preference shares.’

Ordinary shares are issued to the owners of a company. These shareholders have the right to participate in the runningof the company through voting. They also share in the profits of the company through increases in the market value oftheir shares and through the receipt of dividends.

Ordinary shareholders have no right to be paid dividends, however. In addition, should the company run into financialdifficulties, ordinary shareholders are the last group of people to be paid back from the sale of the company’s assets. Inpractice, this means that the capital they invested in the company will usually be lost.

Ordinary shares are therefore a high risk investment. As Mr and Mrs Brute are very risk averse and have already lostmoney on the stock exchange before, they should not purchase ordinary shares.

Preference shares are shares that have a fixed percentage dividend that is payable in priority to any ordinary dividend.Similarly, preference shareholders will be paid in priority to ordinary shareholders on dissolution of the company.

These shareholders will not participate in the affairs of the company in the same way as ordinary shareholders sincethey do not have the same voting rights.

Whilst the income from preference shares is more secure than the income from ordinary shares, the capital is still highrisk. Given Mr and Mrs Brutes’ previous experience, preference shares are not a good choice of investment for them.

(iv) Bills of exchange

A bill of exchange is an unconditional order in writing to pay money.

There are two types of bills of exchange. Firstly, ‘sight bills’, whereby the money is payable on demand. Secondly, ‘termbills’, whereby the money is payable at a future date.

The maturity of term bills can vary from two weeks to six months. Their maximum value is £500,000 and they can bedenominated in any currency.

The ‘drawee’ is the party liable to pay the money; the ‘payee’ is the person who receives the money.

Banks and non-banking institutions are the main buyers of bills on the secondary market.

The buyer makes a profit by purchasing the bill at a discount to its face value, then receiving the full value at maturity,or reselling it before this time.

The level of risk attached to bills depends on the credit quality of the drawer. If the drawer is a large company orinstitution, the risk will be lower than if the drawer is relatively small and unknown.

Bills are not really a suitable investment for Tots Ltd as they are not in a good position to start assessing the credit qualityof drawers. Bills are more suitable for financial institution investors.

13

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14

2 – Pooch Ltd

(a) Working capital

Sales for the year: £2,200,000–––––––––––

The costs for the year are:

Raw materials ££2,200,000 x 15% 330,000Direct labour£2,200,000 x 20% 440,000Variable production overheads£2,200,000 x 11% 242,000Fixed production overheads£2,200,000 x 10% 220,000Other costs£2,200,000 x 12% 264,000

––––––––––1,496,000––––––––––––––––––––

Current assets:Stock £ £Raw materials 4/52 x £330,000 25,385W-I-PMaterials 2/52 x £330,000 x 75% 9,519Direct labour 2/52 x £440,000 x 50% 8,462Variable and fixed production overheads 2/52 x (£242,000 + £220,000) x 50% 8,885

26,866Finished GoodsMaterials and direct labour 4/52 x (£330,000 + £440,000) 59,231Variable and fixed production overheads 4/52 x (£242,000+ £220,000) 35,538

94,769––––––––

Total stock value 147,020Debtors 6/52 x £2,200,000 253,846

––––––––Total value of current assets 400,866

––––––––Current liabilitesMaterials creditor 4/52 x £330,000 25,385Labour creditor 1/52 x £440,000 8,462Variable production overhead creditor 8/52 x £242,000 37,231Fixed production overhead creditor 5/52 x £220,000 21,154Other costs creditor 12/52 x £264,000 60,923

–––––––– ––––––––Total value of current liabilities 153,155

––––––––Working capital required ––––––––(£400,866 – £153,155) 247,711

––––––––––––––––

(b) Legal terms

OfferAn ‘offer’ is a definite promise to be bound on specific terms.

It can be made orally or in writing. It can also be implied from a person’s conduct by, for example, despatching goods inresponse to an offer to buy.

It can be revoked at any time before it has been accepted.

Acceptance‘Acceptance’ is the unconditional agreement, by the offeree, to all the terms of the offer.

As with an offer, it can also be oral, written or implied from a person’s conduct.

A request for information about an offer is not acceptance.

Consideration‘Consideration’ is one party doing something in exchange for another party doing something.

Often, there is simply an exchange of promises, for example, Petcoats Ltd promises to supply items to Pooch Ltd and Pooch Ltd promises to pay them.

Consideration is often simply the price. For example, when one of Pooch Ltd’s customers buys an item in the shop, theirconsideration is the amount they pay for the goods.

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3 – Taxi Ltd

(a) Net present valueYears

0 1 2 3 4 5 Net Present£’000 £’000 £’000 £’000 £’000 £’000 Value

Implementation costs –700 –700 –700Training costs –425Increased revenues (1) 0 800 1,150 1,528 1,934 2,371Cost savings (2) 0 110 116 121 127 134Operative costs (3) 0 –120 –200 –210 –221 –232Maintenance costs 0 –75 –75 –75 –75 –75

––––– ––––– ––––– –––––– –––––– ––––––Net cash flow –700 –410 291 1,364 1,765 2,198

10% discount factors 1·000 0·909 0·826 0·751 0·683 0·621––––– ––––– ––––– –––––– –––––– ––––––––––– ––––– ––––– –––––– –––––– –––––– ––––––

Discounted cash flow –700 –373 240 1,024 1,205 1,365 2,761––––– ––––– ––––– –––––– –––––– –––––– ––––––

Notes1. Increased revenues Years

1 2 3 4 5£’000 £’000 £’000 £’000 £’000

Revenues + 5% each year 11,000 11,550 12,128 12,734 13,371Without Kwictrac –10,200 –10,400 –10,600 –10,800 –11,000

–––––––– –––––––– –––––––– –––––––– ––––––––Increased revenue 800 1,150 1,528 1,934 2,371

–––––––– –––––––– –––––––– –––––––– –––––––––––––––– –––––––– –––––––– –––––––– ––––––––

2. Savings in costsAnnual revenues 11,000 11,550 12,128 12,734 13,371

–––––––– –––––––– –––––––– –––––––– ––––––––Savings at 1% 110 116 121 127 134

–––––––– –––––––– –––––––– –––––––– –––––––––––––––– –––––––– –––––––– –––––––– ––––––––

3. Operative costs–––––––– –––––––– –––––––– –––––––– ––––––––

Additional costs (+ 5% from T3) 120 200 210 221 232–––––––– –––––––– –––––––– –––––––– –––––––––––––––– –––––––– –––––––– –––––––– ––––––––

4. Ignore depreciation as not a cash flow.

5. Ignore interest as this is already taken into account in the discounting process.

(b) Simple Payback

Time Annual cash flows Cumulative cash flows0 –700 –7001 –410 –1,1102 291 –8193 1,364 5454 1,765 2,3105 2,198 4,508

The simple payback period for the project is three years. This means that in three years’ time, the project has recovered itscosts and is then making a profit.

(c) Discounted Payback Period

Time Annual cash flows Cumulative cash flows0 –700 –7001 –373 –1,0732 240 –8333 1,024 1914 1,205 1,3965 1,365 2,761

The discounted payback period for the project is also three years. This means that in three years’ time, the project hasrecovered its costs and is then making a profit. As this calculation is for the discounted payback period, the time value ofmoney has also been taken into account.

(Note: Students will still be awarded full marks where they have not rounded their calculations to the nearest year.)

15

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16

(d) Time deposits

First instalment of £700,000:

1Amount required now = £700,000 × ———(1·08)

Amount required now = £648,148

Second instalment of £700,000:

1Amount required now = £700,000 × ———(1·09)2

Amount required now = £589,176

Total deposits = £1,237,324

4 – Skint Ltd

(a) Factors considered by a bank

The factors to be considered are set out below.

The character of the borrowerBefore lending money, the bank will need to decide whether the borrower is of good character. This will involve looking at theborrower’s past record and conducting a personal interview with the applicant.

If a person is applying for a loan, they will often be credit scored. If a company is making the application, the bank willprobably use key ratios to analyse the company’s financial position.

The ability to borrow and repayThe bank looks at a business customer’s financial performance in order to ascertain their likely future position.

If the owner re-invests profits in the business rather than drawing them all out, it shows that he has some confidence in thesuccess of the business. This makes the bank more likely to lend to the business.

When dealing with a company that is applying for finance, the bank may check whether the company has the authority toborrow the funds it is requesting. The company’s articles of association provide this information.

The margin of profitsThe bank lends money in order to make money. It needs to ensure that it makes enough of a profit to warrant the risk that ittakes by lending.

Most banks have lending policies which require them to charge different interest rates to customers depending on the reasonfor the borrowing. This is because some types of lending are more risky than others.

Ultimately, it is the bank’s discretion to charge whatever interest rate it chooses. For risky ventures, the rate will obviouslybe higher.

Purpose of the borrowingThe purpose of the borrowing affects not only the interest rate but also the bank’s decision as to whether or not to lend in thefirst place.

A bank will not lend money for an illegal purpose. It will normally lend in order to finance working capital, provided that thecompany’s liquidity position is still manageable.

Lending to finance new business ventures is more risky since many of them fail. The bank will be more cautious in thesecases.

Amount of the borrowingFirstly, the bank will need to make sure that the applicant is not asking for more money than he needs for the purposespecified. If he is, this casts doubt over his ability to repay.

Secondly, the bank needs to be sure that the applicant is asking for enough money. If he is not, the bank may well end uphaving to lend more in order to safeguard the original loan.

Repayment termsThe bank must not lend money to a person or company who does not have the ability to repay it, with interest, irrespectiveof any security available for the loan. Security should only be called upon as a last resort if there is a sudden unexpectedinability to pay.

A repayment term should be set which is realistic. Overdrafts are repayable on demand and are therefore more risky for theborrower.

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Insurance against the possibility of non-paymentWhen lending large sums of money to an individual or to a company, the bank may well ask for the loan to be secured. Thissecurity may take the form of title deeds to property – either property of the company or the individual’s house, dependingon who is making the application for finance.

A borrower may take out payment protection insurance, so that his repayments are covered even if his financial positiondeteriorates.

(b) Three characteristics

The three characteristics for security are as follows:

(i) Easy to takeThis means that the security should be easy to obtain in the first place, for example, title documents to property.

(ii) Easy to valueThe security should have a clearly identifiable value which is either stable or increasing, and which fully covers thelending amount and the margin of profit.

(iii) Easy to realiseThe security should ideally be readily available for sale. This ensures that the bank’s administrative costs are kept to aminimum. Also, the risk of the security deteriorating between the time of default and the time of sale is minimised.

(c) Three terms

(i) Bullet repayment loanNone of the principal amount lent is repaid until the end of the loan period. The principal is then repaid in one big lumpsum.

(ii) Balloon repayment loanSome of the principal is repaid during the term of the loan. A final substantial payment is then made at maturity.

(iii) Amortising loan (straight repayment loan)The principal is repaid gradually over the term of the loan, along with the interest payments. Some mortgages are repaidin this way.

17 [P.T.O.

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2004 Marking Scheme

Marks1 (a) Cash sales 3

Rental income 1Purchases 2Permanent staff 1Temporary staff 1Delivery 1Administration 2Conference 1Ignoring depreciation 1Computer system 1Net cash flow/op bal/clos bal 2

–––16–––

(b) Each motive discussed 2–––

Maximum marks 6–––

(c) (i) CDsNegotiable instrument 1Transfer of title 1Banks and BSs issue 1Deposit amount 1Repayment length 1Obtaining repayment 1Attractive interest 1Low risk 1Useful for short term 1Conclusion for Tots Ltd 1

–––Max marks 6

–––

(ii) GiltsMarketable Gov securities 1Face value usually £100 1Fixed interest rates 1Index-linked 1Shorts/mediums/longs 1Low risk if hold until repd 1Explaining price/int rates rel 1Higher if on secondary 1Minimum investment 1Electronic transfer available 1Conclusion re Tots Ltd 1

–––Max marks 6

–––

(iii) SharesTwo types 1Ordinary shares:– voting rights 1– share in profits 1– no right to dividends 1– loss of capital 1– conclusion 1

Preference shares:– preferential dividends 1– preference on winding up 1– lack of participation 1– conclusion 1

–––Max marks 6

–––

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Marks(iv) Bills of exchange

Definition 1Two types 1Term bill details 1Drawee and payee 1Main buyers 1Making a profit 1Risk 1Conclusion re Tots Ltd 1

–––Max marks 6

–––Total marks 40

––––––

2 (a) Calculation of each cost for yr 0·5–––

Max marks 2·5–––

Calculation of current assets:Raw materials 0·5WIP 4Finished goods 2Debtors 0·5

–––7

–––

Calculation of current liabsMaterials creditor 0·5Labour creditor 0·5Variable overheads 0·5Fixed overheads 0·5Other costs 0·5

–––2·5–––

Working capital required 1

Presentation 1–––14–––

(b) Definition of offer 1Orally/in writing/implied 1Withdrawal 1

–––Max marks 2

–––

Definition of acceptance 1Orally/in writing/implied 1Request for information 1

–––Max marks 2

–––

Definition of consideration 1Exchange of promises 1Price 1

–––Max marks 2

–––Total marks 20

––––––

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Marks3 (a) Implementation costs 1

Training costs 1Increased revenues 3Decreased costs 1Operative costs 1Maintenance costs 1Ignore depreciation and interest 1NPV 1

–––10–––

(b) Net cashflows 1Cumulative cashflows 1Interpretation and result 1

–––3

–––

(c) Discounted net cashflows 1Cumulative cashflows 1Interpretation and result 1

–––3

–––

(d) One year deposit 2Two year deposit 2

–––4

–––Total marks 20

––––––

4 (a) Character of borrower 2Ability to repay 2Margin of profit 2Purpose of borrowing 2Amount of borrowing 2Repayment terms 2Insurance 2

–––14–––

(b) Each characteristic 1–––

Total 3–––

(c) Each explanation 1–––

Total 3–––

Total marks 20––––––

21

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Managing Finances

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

ADVANCED LEVEL

WEDNESDAY 15 JUNE 2005

QUESTION PAPER

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examinationhall

The Association of Chartered Certified Accountants

Pape

r T1

0

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Page 47: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

ALL FOUR questions are compulsory and MUST be attempted

1 Seventeen LtdSally Sharp is the Managing Director of Seventeen Ltd, a production company responsible for the huge success of thetelevision programme ‘Pop Icon 1’ and ‘Pop Icon 2.’ The programme is just nearing the end of the second series, withonly four weeks to go before the public chooses a winner.

Sally is in the process of deciding whether to run a ‘Pop Icon’ tour. This would consist of twelve live performances, intwelve different locations, during the month of September. The twelve finalists from the television programme wouldall take part in the tour. Seventeen Ltd ran a ‘Pop Icon 1’ tour after the first series and this was a big success. Sallyis concerned, however, about the effect of the tour on the company’s cash flow, as the company currently has fundstied up in several other projects.

You have been provided with the following information:

(i) Seventeen Ltd will open a separate bank account on 1 July 2005 for the tour, with an opening balance of£500,000.

(ii) During the Pop Icon 1 tour, it was calculated that for each thousand votes cast during the final twelve televisionprogrammes, one person attended the Pop Icon tour. This ratio is expected to remain the same for the secondPop Icon tour, should it go ahead.

During the last eight weeks of Pop Icon 2, the public has cast a total of 180 million votes. This is an average of22·5 million votes per week. Public interest is expected to increase over the final four weeks and it is thereforeestimated that votes for the remaining four weeks will be 100 million in total.

(iii) Tickets vary in price according to the seat location within each venue. Ticket information is as follows:

Ticket type Price Percentage of total tickets soldPremium seats £35 10%Arena floor £30 30%Stalls £25 60%

It is expected that 20% of ticket revenues will be received in September, 30% in October, 30% in November andthe remainder in December.

(iv) At every live performance, a selection of souvenirs will be on sale, from mugs and t-shirts to CDs and DVDs.From the Pop Icon 1 tour it has been calculated that for every ticket sold, an average of £6 is spent on souvenirs.These monies are received by Seventeen Ltd in September.

(v) The souvenirs are purchased from two key suppliers – Records Ltd, who produce all the CDs and DVDs (50% oftotal souvenirs sales), and Junk Ltd who produce everything else (remaining 50% of sales). The gross profitmargins for Seventeen Ltd are 25% for CDs and DVDs and 50% for everything else. All orders must be madefrom both suppliers in August but whereas Records Ltd requires payment at the time of order, Junk Ltd providesone month’s credit.

(vi) Each of the twelve performers will be paid £35,000 for his/her participation in the live tour. Of this amount,£5,000 will be paid at the start of the tour at the beginning of September, with the remainder being paid at thebeginning of October.

(vii) Seventeen Ltd will pay an average of £150,000 to hire each of the twelve venues for the live tour. In order tosecure the venues, a deposit of 10% had to be paid in May for each venue out of one of the company’s existingbank accounts. The remaining balances will be paid in August from the Tour bank account.

(viii) Seventeen Ltd will need to hire two tour buses in September – one for the performers and one for the crew. Thecost of these will be £10,000 each. In addition to these, six heavy vehicles will be required to transportequipment. Each vehicle costs £12,000. All of these transport costs include driver costs and fuel. 75% of thetotal transport costs (including buses) will be paid in September, with the remainder being paid in October.

(ix) For each performer on the tour, five members of crew are required over and above the already existing staff ofSeventeen Ltd. The average gross wage of each crewmember is £12,000 per month. Whilst all of thesecrewmembers are required for the month of September, only half of them are needed for August. Allcrewmembers are paid at the end of each month that they work.

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(x) The crewmembers are hired through an agency, Hands on Deck Ltd. The agency charges a fee for each memberof crew hired through them. The fee is calculated as 10% of the gross monthly wage of each crewmember andis paid for EVERY month that they work. Hands on Deck Ltd allows one month’s credit.

(xi) Publicity for the tour is expected to cost a further £2·5 million. Of this amount, 20% will be paid in July and30% paid in August. Sally has negotiated delaying the remaining payment until November.

(xii) Other costs are estimated to be in the region of £240,000 IN TOTAL, incurred evenly through the months of July,August, September and October. They will be paid in the month in which they are incurred.

(xiii) All workings should be in £’000, to the nearest £’000.

Required:

(a) Prepare a monthly cash budget for the Pop Icon 2 Tour for EACH of the six months to 31 December 2005,showing clearly any necessary workings. (30 marks)

The following information applies to part (b) only.Sally is concerned that the above calculations rely on the public’s average weekly votes increasing in the final fourweeks of the programme. They also rely on the assumption that there will be one ticket sale per thousand votes. Sallyis concerned about the effect on profit should these assumptions be wrong, with the second tour proving to be lesspopular that the first one. She now wants you to assume that voting for the final four weeks of the programme staysat the same average level as the previous eight weeks AND that for every TWO thousand votes only one person attendsthe tour.

(b) Calculate the original profit of the project as per part (a) AND the revised profit/loss after the change in theassumptions. (10 marks)

(40 marks)

3 [P.T.O.

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2 Silly Filly LtdSilly Filly Ltd is a recently established company specialising in the manufacture of talking toy horses for children. TheSilly Filly range currently comprises three key products – all of which are toy horses – plus approximately thirtyaccessories to complement the range, from stables to grooming kits.

The Silly Filly range has been such a success in the last year that the management is considering producing ananimated film to accompany the range. This is in accordance with the company’s long-term expansion plans,culminating in a stock exchange flotation in three year’s time.

The film will take one year to make. In the year following that, sales of the film will commence.

You, an accounting technician for the company, have been asked to assist in appraising the project to decide whetherit should go ahead. The following information is relevant to your calculations.

(i) Market research has already been carried out at a cost of £1·2 million.

(ii) The services of a company specialising in animation will be required at a total cost of £520,000. 50% of thesecosts will be paid immediately with the remainder being paid in one year’s time.

(iii) Two producers will be employed throughout the first year of the project. They will each be paid salaries of£120,000.

(iv) Other production costs during the year are expected to be £650,000.

(v) A film director will be employed immediately on a one-year contract at a cost of £160,000.

(vi) The animated film is expected to generate revenues of £1·2 million in the first year of sales, £2·2 million in thesecond year, and £1·6 million in the third year.

(vii) The two producers and the director will each be paid royalties from the film. These will be paid at the rate of1·5% of gross revenues for EACH of the producers and 2% for the director. They will always be payable one yearin arrears.

(viii) Specialist equipment will need to be purchased immediately for the film production. This will cost £2·3 millionbut can be sold at the end of the year for £1·7 million.

(ix) A loan for £1 million will be taken out to assist in financing the project. The loan will be repayable in two year’stime, with interest of 8% per annum being payable for its duration.

(x) The company’s cost of capital is 10% per annum.

(xi) Assume that all cash flows occur at the end of each year, unless otherwise stated.

Required:

(a) Using the present value tables provided at the end of the question, calculate the project’s net present value(NPV) at the company’s cost of capital. Conclude as to whether the company should proceed with theproject, giving a reason for your conclusion. (10 marks)

(b) List four costs associated with a new equity issue. (4 marks)

(c) Explain three reasons why a company may seek a stock exchange listing. (6 marks)

Present Value table (extract)Periods (n) Discount rate (r) Discount rate (r)

10% 8%1 0·909 0·9262 0·826 0·8573 0·751 0·7944 0·683 0·7355 0·621 0·681

(20 marks)

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3 Duel Fuel LtdDuel Fuel is an energy company that buys gas in bulk and sells it to the main market providers in the UK. Thecompany’s credit control department is poorly run at present, following the resignation six months ago of the creditcontroller. Poor credit control has had a serious effect on the company’s overdraft, which currently stands at £5million, compared to £3 million at the same time last year. This, in turn, is pushing up interest costs.

The company is therefore considering factoring its debts to improve its cash flow and reduce costs.

Credit sales for the last year totalled £8·5 million, with average debtors of £4·3 million. Next year, sales are expectedto be 20% higher, and debtor days are expected to remain the same if the factoring arrangement is NOT entered into.

A factoring company has put forward the following proposal to Duel Fuel Ltd:

(i) The factor would immediately advance 70% of the value of sales invoices.(ii) The factor will charge interest of 12% per annum on the advances.(iii) The factor will charge an administration fee of 1·5% of turnover for the service.(iv) Debtor days will be reduced to 60 days, the industry norm, as a result of stricter credit control procedures

Should Duel Fuel Ltd enter into the agreement, it will make both of the credit control staff redundant. They earnsalaries of £14,000 per annum each, but they will both be paid a redundancy package of £3,000 each.

Current bank overdraft rates are 9% per annum.

Required:

(a) Calculate for the coming year whether it is financially viable for Duel Fuel Ltd to factor its debts.(10 marks)

(b) Identify five advantages of factoring. (5 marks)

(c) List five functions that a credit control department may undertake. (5 marks)

(20 marks)

5 [P.T.O.

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4 Gym Jam LtdGym Jam Ltd is a well-established company that hires out a range of top quality treadmills to gyms across the country,under operating leases.

Over recent months, Gym Jam Ltd’s client base has expanded so rapidly that the company has struggled to financethe level of treadmill purchases required to supply its new clients. The company used a loan from its local bank toassist with its last bulk order of treadmill purchases two years ago. Interest on this loan was variable, being linked tothe bank’s base rate, and Gym Jam Ltd saw its interest charges steadily increasing over the two-year period. It isnow considering using finance leases (fixed interest) to acquire the next bulk order of treadmills.

In the last year, the company’s debtor days have increased from an average of 30 days to 45 days, partly becausesales ledger staff could not cope with the increased workload. Currently, all customers are invoiced every three months(quarterly) for the hire of the treadmills, and most of them pay by cheque. Invoices are raised manually and state onthem that payment terms are 30 days from invoice date.

You are an accounting technician for the company, and have been asked to assist in resolving these problems.

Required:

(a) Briefly describe three key characteristics of an operating lease. (3 marks)

(b) Briefly describe five key characteristics of a finance lease. (5 marks)

(c) Identify four weaknesses in Gym Jam Ltd’s invoicing and credit control system and indicate how they canbe rectified. (4 marks)

(d) List the factors that affect the rate of interest for a loan. (6 marks)

(e) Explain why the interest charges on Gym Jam Ltd’s loan kept increasing. (2 marks)

(20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2005 Answers

1 (a) Seventeen LtdNote Jul Aug Sep Oct Nov Dec Total

£’000 £’000 £’000 £’000 £’000 £’000 £’000Cash inflowsTicket sales 1 1,540 2,310 2,310 1,540 7,700Souvenirs sales 2 1,680 1,680

––––– ––––– ––––– ––––– –––––Total cash inflows 3,220 2,310 2,310 1,540 9,380

––––– ––––– ––––– ––––– –––––Cash outflowsPurchases: Records Ltd 3 630 630Purchases: Junk Ltd 3 420 420Performers 4 60 360 420Venue costs 5 1,620 1,620Transport costs 6 69 23 92Crew costs 7 360 720 1,080Agency fees 8 36 72 108Publicity costs 9 500 750 1,250 2,500Other costs 60 60 60 60 240

––––– ––––– ––––– ––––– ––––– ––––– –––––Total cash outflows 560 3,420 1,365 515 1,250 0 7,110

––––– ––––– ––––– ––––– ––––– ––––– –––––Net cash flow (560) (3,420) 1,855 1,795 1,060 1,540 2,270Opening balance 500 (60) (3,480) (1,625) 170 1,230 500

––––– ––––– ––––– ––––– ––––– ––––– –––––Closing balance (60) (3,480) (1,625) 170 1,230 2,770 2,770

––––– ––––– ––––– ––––– ––––– ––––– –––––

Note: The ‘Total’ column above is not required but does provide a useful arithmetic check for accuracy.

Note 1 Ticket salesTotal votes(180,000,000 + 100,000,000) 280,000,000

Estimated ticket sales(280,000,000/1,000) 280,000Allocated as follows:Premium seats £’000(280,000 x 10% x £35) 980Arena floor(280,000 x 30% x £30) 2,520Stalls(280,000 x 60% x £25) 4,200

––––––Total revenues 7,700

––––––Received in:September (£7,700,000 x 20%) 1,540October (£7,700,000 x 30%) 2,310November (£7,700,000 x 30%) 2,310December (£7,700,000 x 20%) 1,540

––––––––7,700

––––––––

Note 2: Souvenirs sales £’000Total number of tickets sold 280,000Average souvenirs sale each 6Total souvenirs sales 1,680

––––––––

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Note: 3 Souvenirs purchases £’000Total souvenirs sales 1,680Split as follows:DVDs/CDs – 50% 840GPM at 25% (210)

––––––––Therefore COS at 75% 630Payable in August to Records Ltd ––––––––

Other souvenirs – 50% 840GPM at 50% (420)

––––––––Therefore COS at 50% 420Payable in September to Junk Ltd ––––––––

Note 4: Performers £’00012 performers at £35,000 each 420Split as follows:Due September (12 x £5,000) 60Due October (12 x 30,000) 360

––––––––

Note 5: Venue costs £’00012 venues at £150,000 each 1,800Less deposits paid (10% x £1,800,000) (180)

––––––––Remainder due in August 1,620

––––––––

Note 6: Transport costs £’0002 tour buses (2 x £10,000) 206 heavy goods vehicles (6 x £12,000) 72

––––––––Total 9275% due September 69

––––––––25% due October 23

––––––––

Note 7: Crew costs £’000Total number of crew required (12 x 5) 60Total cost for August (30 x £12,000) 360

––––––––Total cost for September (60 x £12,000) 720

––––––––

Note 8: Agency fees £’000August staff30 x £12,000 x 10% 36Due September ––––––––September staff60 x £12,000 x 10%Due October 72

––––––––

Note 9: Publicity costs £’000July: £2,500,000 x 20% 500

––––––––Aug: £2,500,000 x 30% 750

––––––––Nov: £2,500,000 x 50% 1,250

––––––––

Note 10: Other costs £’000July – Oct: £240,000/4 60

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(b) Recommended method of calculationOriginal level of profit per (a) £’000Income 9,380Less: expenditure per cash budget (7,110)Less: venue deposits pd May (180)

–––––––Profit 2,090

–––––––Revised level of profit/loss £’000Revised income: (£9,380 x 270/280) x 1/2 4,523Less original expenses: (7,110)

(180)Add: original souvenir expenses (£630 + £420) 1,050Less revised souvenir expenses:(£1,050 x 270/280) x 1/2 (506)

–––––––Revised loss (2,223)

–––––––

Alternative method for calculating revised profit/lossRevised profit/loss £’000 £’000Ticket sales (note 1) 3,713Souvenirs sales (note 2) 810

––––––– 4,523Less expensesPer original cash budget (7,110)Less venue deposits paid May (180)Add back original souvenir expenses 1,050Less revised souvenir expenses (note 3) (506)

––––––– (6,746)––––––––

Revised loss (2,223)––––––––

Note 1: Revised ticket salesTotal votes(180,000,000 + 90,000,000) 270,000,000Estimated ticket sales(270,000,000/2,000) 135,000Allocated as follows:Premium seats £’000(135,000 x 10% x £35) 473Arena floor(135,000 x 30% x £30) 1,215Stalls(135,000 x 60% x £25) 2,025

––––––––Total revenues 3,713

––––––––Note 2: Revised souvenirs sales £’000Total number of tickets sold 135,000Average souvenirs sale each 6Total souvenirs sales 810

––––––––

11

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Note 3: Revised souvenirs purchases £’000Total souvenirs sales 810Split as follows:DVDs/CDs – 50% 405GPM at 25% 101

––––––––Therefore COS @ 75% 304

––––––––Other souvenirs – 50% 405GPM at 50% 203

––––––––Therefore COS at 50% 202

––––––––Total souv. expenses (£304,000 + £202,000) 506

––––––––

2 Silly Filly Ltd(a) NPV

0 1 2 3 4 5£’000 £’000 £’000 £’000 £’000 £’000

Revenues 1,200 2,200 1,600Market research – sunk costAnimation company costs (260) (260)Producers’ salaries (240)Other production costs (650)Director’s salary (160)Royalties (note 1) (60) (110) (80)Specialist equipment (2,300) 1,700Loan interest – irrelevant

–––––– –––––– –––––– –––––– –––––– ––––––Net relevant cash flows (2,560) 390 1,200 2,140 1,490 (80)Discount factor 1 0·909 0·826 0·751 0·683 0·621

–––––– –––––– –––––– –––––– –––––– ––––––Discounted cash flow (2,560) 355 991 1,607 1,018 (50)

–––––– –––––– –––––– –––––– –––––– ––––––

The project should be undertaken as it has a positive NPV of £1·361 million.

Note 1: Royalties Years0 1 2 3 4 5

Revenues 1,200 2,200 1,600–––––– –––––– ––––––

Royalties: (2 x 1·5% + 2% = 5%) 60 110 80–––––– –––––– ––––––

(b) Four costs of new equity issues– Underwriting costs– Stock exchange listing fees– Costs of printing and distributing the prospectus– Advertising costs– Issuing house fees– Solicitors’ fees– Public relations consultancy fees– Accountants’ fees(Note: Only four were required.)

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(c) Reasons for a stock exchange listingAccess to wider pool of financeThe level of finance available to a private unlisted company is limited. Therefore, if a company needs more finance than iscurrently available to it, it may seek a stock exchange listing. A stock exchange listing may also improve the company’s creditrating, meaning that more investors are willing to invest in it.

Enhancement of the company imageA company’s image is generally improved anyway when it becomes listed, as it is perceived as being more financially stable.This may result in increased custom and increased buying power.

Increased marketability of sharesIt is not very easy for a shareholder in a private company to sell his/her shares, and this in itself makes the investment morerisky. Once a company is listed on the stock exchange, its shares become far more marketable, thus making them far moreattractive.

Facilitation of growth by acquisitionShould a listed company wish to make an offer to takeover another company, they are in a much better position to do so thanan equivalent unlisted company. This is because the terms of the offer will probably include an exchange of the shares in theacquiring company for those of the target company.

Transfer of capital by founder ownersA stock exchange listing gives founder members more opportunity to sell their shareholding, or part of it, leaving them freeto invest in other projects.

Note: Only three reasons were required.

3 Duel Fuel Ltd(a) Whether to factor

Existing finance cost at 9%New level of debtors = £4,300,000 x 120% £5,160,000Overdraft cost per annum = £5,160,000 x 9% £464,400

––––––––––

Cost of factoringNew sales level = £8,500,000 x 120% £10,200,000Debtors reduced to 60 days:£10,200,000 x 60/365 £1,676,71270% advanced by factor at 12%: ££1,676,712 x 70% x 12% 140,84430% still financed by overdraft:£1,676,712 x 30% x 9% 45,271Admin Fee:£10,200,000 x 1·5% 153,000Saved salaries(2 x £14,000) – (2 x £3,000) (22,000)

––––––––––317,115

––––––––––Saving = £464,400 – £317,115 147,285

––––––––––

ConclusionIt is financially viable for Duel Fuel Ltd to factor its debts as a total saving of £147,285 will be made.

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(b) Advantages of factoring(i) Managers can concentrate on running the business rather than spending time dealing with problems relating to slow

paying debtors.

(ii) The factor will run the company’s sales ledger department, hence cutting running costs in this area.

(iii) The company’s cash flow position is improved, such that the company can pay its suppliers promptly and benefit fromearly payment discounts.

(iv) The finance costs of the business are linked to its sales levels and will therefore only increase as sales levels increase.

(v) Expansion can be financed through sales, rather than through increased debt or any injection of capital.

(vi) Optimum stock levels can be maintained, since the cash is readily available for injection.

(vii) Insurance against the company’s bad debts is provided, since the factor takes over the risk of these losses if theagreement is a ‘without recourse’ agreement.

Note: Only five advantages were required:

(c) Roles of credit control department– Keeping the sales ledger up-to-date– Pursuing overdue debts– Investigating customers’ creditworthiness– Dealing with customer queries about their account– Advising customers on payment terms– Giving references to third partiesNote: Only five roles were required.

4 Gym Jam Ltd(a) Operating lease

– This is a rental agreement between two parties, whereby the lessor supplies equipment to the lessee.– The lessor usually retains the responsibility for servicing and maintaining the leased equipment.– The period of the lease is usually shorter than the asset’s expected useful economic life.

(b) Finance lease– This is an agreement between the lessor, who provides finance for the asset, and the lessee.– The person supplying the equipment is usually a third party; the lessor just finances the asset.– The lessee is responsible for the service and maintenance of the asset.– The lease has a primary period which covers all/most of the expected useful economic life of the asset.– The lease usually has an indefinite secondary period whereby the lessee continues to lease the asset for a nominal rent.

(c) Weaknesses and rectifications– Invoices are only raised quarterly, and using an inefficient manual system. A computerised invoicing system should be

introduced that automatically raises invoices every month.– Cheques are a slow method of payment, and rely on the customer sending them by post. Direct debits should be set up

for customer payments instead.– There are insufficient sales ledger staff to cope with the workload and this is causing a backlog. Additional sales ledger

staff should be recruited to assist with the increased workload.– Customers are not penalised for late payment and are therefore paying late. An interest penalty should be imposed on

all late payments. Customers should be notified of this on their invoices.

(d) Factors affecting interest rate on loan– Level of risk– Interest rates in the economy– Status of the borrower– Security offered by the borrower– Amount of the loan– Purpose of the loan– Duration of the loan

(e) Increase in interest chargesInterest charges persisted in increasing because the loan was linked to the Bank’s base rate. A bank’s base rate is based onLIBOR – the London Inter-Bank Offered Rate. LIBOR is the rate at which a bank can borrow money on the Inter-bank market.This LIBOR rate must have gone up, leading to an increase in Gym Jam Ltd’s bank’s base rate, and hence the rate of intereston the loan.

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2005 Marking Scheme

Marks1 (a) Cash budget

Total votes cast 1Total tickets bought 1Premium sales 1Arena sales 1Stalls sales 1Total sales 1Ticket sales – Sept 1Ticket sales – Oct 1Ticket sales – Nov 1Ticket sales – Dec 1Souvenirs Sales 1Souvenirs Purchases – CDs 2Souvenirs Purchases – Other 2Performer costs – Sept 1Performer costs – Oct 1Venue costs 1Transport costs – Sept 1Transport costs – Oct 1Crew costs – Aug 1Crew costs – Sept 1Agency costs – Sept 1Agency costs – Oct 1Publicity costs 1Other costs 1Net cash flows 1Opening bank balances 1Closing balances 1Presentation 1

–––Total 30

–––

(b) Profits – recommended methodCurrent profit figure 3Revised income 2Original expenses 1Add back souvenir expenses 1Revised souvenir expenses 2Loss figure 1

–––Total 10

–––Total marks 40

–––

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Marks2 (a) NPV

Revenues 1Market research – sunk cost 1Animation company costs 1Producers’ salaries 0·5Director’s salary 0·5Other production costs 0·5Royalties 1Special equipment 1Loan interest – irrelevant 1Discounted cash flow 1·5Conclusion 1

–––Total 10

–––

(b) Costs of new equity issueFor each cost 1

–––Max marks 4

–––

(c) Stock exchange listingFor each reason explained 2

–––Max marks 6

–––Total marks 20

–––

3 (a) Whether to factorNew sales level 1Current cost 1New debtors level 1Debtors at 60 days 1Cost of 70% advanced 1Cost of 30% not advanced 1Admin fee 1Saved salaries 1Factor saving 1Conclusion 1

–––Total 10

–––

(b) AdvantagesFor each advantage 1

–––Max marks 5

–––

(c) RolesFor each role 1

–––Max marks 5

–––Total marks 20

–––

16

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Marks4 (a) Operating lease

For each characteristic 1–––

Max marks 3–––

(b) Finance leaseFor each characteristic 1

–––Max marks 5

–––

(c) Weaknesses/rectificationsComputerised invoicing 1Changing payment method 1More staff 1Interest penalty 1

–––4

–––

(d) Interest rate factorsEach factor 1

–––Max marks 6

–––

(e) Increasing interestBase rate must have increased 1/2Base rate based on LIBOR 1/2LIBOR explained 1/2LIBOR must have increased 1/2

–––2

–––Total marks 20

–––

17

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Managing Finances

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

ADVANCED LEVEL

WEDNESDAY 14 DECEMBER 2005

QUESTION PAPER

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examinationhall

The Association of Chartered Certified Accountants

Pape

r T1

0

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ALL FOUR questions are compulsory and MUST be attempted

1 Gold Club Ltd is a newly established company that has not yet commenced trading. The two shareholders/directorsare planning to set up an Internet business. With the help of finance from venture capitalists, they plan to set up awebsite through which individuals can join a ‘Gold Club’. Membership of the club will provide members with a rangeof quality travel services including access to a First Class lounge at airports, travel insurance for an unlimited numberof trips and discounted upgrades for seats on flights. It will take one year to set up the business.

You are an accounting technician who has been asked to appraise the investment of capital in the project based ona six-year plan (one year to set up the business followed by five years of operation).

(i) Market research has been carried out at a cost of £200,000. This indicates that the number of new membersjoining the club would be approximately 5,000 each year. Of these new joiners each year, 50% will renew theirmembership ONCE, in the following year.

(ii) Membership fees for new members joining the club each year will be £500. Members renewing theirmembership in the subsequent year will benefit from a reduced annual fee of £400.

(iii) The costs of setting up the website are as follows:– Design costs: £1,220,000– Administrative costs: £125,000– Legal advice fees: £155,000

25% of these costs will be paid immediately as a deposit, with the remainder being paid in one year’s time.

(iv) The costs of the technical support for maintaining the website will be £100,000 for the first year it is in operation.These costs will increase by 20% year-on-year thereafter.

(v) All new members will be issued with a club card, with an electronic chip in it. The cost of this card for Gold ClubLtd will be £3 per member. Once the original card is issued, there will be no need to issue a further card forrenewal of membership. The supplier will be paid annually in arrears for all cards issued in that year. The firstpayment is therefore due at the end of the second year.

(vi) For every member who uses a First Class lounge at any airport worldwide, a charge of £20 will be made to GoldClub Ltd each time the lounge is used. It is estimated that 40% of members will use it three times a year, 30%of members will use it twice a year, 20% will use it once a year and 10% will not use it at all.

(vii) Gold Club Ltd will purchase a travel insurance policy based primarily on the number of members in the scheme.It is assumed that all members will make use of the travel insurance and the supplier will therefore charge GoldClub Ltd £50 per member in the first year, increasing steadily by £2 per member each year after that. Eachmember will have to e-mail the travel insurers with details of their trip in advance of each trip. Therefore, theinsurers will also charge Gold Club Ltd an administrative fee of £2 for every e-mail received. Gold Club Ltdestimates that on average each member will send two e-mails per annum.

(viii) Gold Club Ltd will pay ten major airlines £100,000 EACH per annum in order to provide their members withaccess to discounted seat upgrades.

(ix) Overdraft interest will be £5,000 per annum.

(x) Assume that all cash flows, including the receipt of membership fees, occur at the end of each year, unlessotherwise stated.

(xi) The company’s cost of capital is 10% per annum.

(xii) Workings should be in £’000, to the nearest £’000.

2

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Required:

(a) Using the discount tables provided at the end of the question, calculate the project’s net present value (NPV)at the company’s cost of capital. Conclude as to whether the company should proceed with the project,giving a reason for your conclusion. (30 marks)

(b) Identify and discuss five factors that a venture capital organisation would take into account when decidingwhether or not to invest in Gold Club Ltd. (10 marks)

Present value table (extract)Periods (n) Discount rates (r)

10% 20%1 0·909 0·8332 0·826 0·6943 0·751 0·5794 0·683 0·4825 0·621 0·4026 0·564 0·3357 0·513 0·2798 0·467 0·2339 0·424 0·19410 0·386 0·162

(40 marks)

3 [P.T.O.

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2 Cleanly Ltd is a manufacturing company producing and selling a range of cleaning products to wholesale customers.It has three suppliers and two customers. Cleanly Ltd relies on its cleared funds forecast to manage its cash.

You are an accounting technician for the company and have been asked to prepare a cleared funds forecast for theperiod Monday 2 January to Friday 6 January 2006 inclusive. You have been provided with the following information:

(1) Receipts from customersCustomer name Credit Payment 2 Jan 2006 2 Dec 2005 sales

terms method salesW Ltd 1 calendar month BACS £150,000 £130,000X Ltd None Cheque £180,000 £160,000

(a) Receipt of money by BACS is instantaneous.

(b) X Ltd’s cheque will be paid into Cleanly Ltd’s bank account on the same day as the sale is made and willclear on the third day following this (excluding day of payment).

(2) Payments to suppliersSupplier Credit Payment 2 Jan 2006 2 Dec 2005 2 Nov 2005name terms method purchases purchases purchasesA Ltd 1 calendar month Standing order £65,000 £55,000 £45,000B Ltd 2 calendar months Cheque £85,000 £80,000 £75,000C Ltd None Cheque £95,000 £90,000 £85,000

(a) Cleanly Ltd has set up a standing order for £45,000 a month to pay for supplies from A Ltd. This will leaveCleanly’s bank account on 2 January. Every few months, an adjustment is made to reflect the actual costof supplies purchased (you do NOT need to make this adjustment).

(b) Cleanly Ltd will send out, by post, cheques to B Ltd and C Ltd on 2 January. The amounts will leave itsbank account on the second day following this (excluding the day of posting).

(3) Wages and salariesDecember 2005 January 2006

Weekly wages £12,000 £13,000Monthly salaries £56,000 £59,000

(a) Factory workers are paid cash wages (weekly). They will be paid one week’s wages, on 6 January, for thelast week’s work done in December (i.e. they work a week in hand).

(b) All the office workers are paid salaries (monthly) by BACS. Salaries for December will be paid on 2 January.

(4) Other miscellaneous payments(a) Every Monday morning, the petty cashier withdraws £200 from the company bank account for the petty

cash tin. The money leaves Cleanly’s bank account straight away.

(b) The window cleaner is paid £30 from petty cash every Wednesday morning.

(c) Office stationery will be ordered by telephone on Tuesday 3 January to the value of £300. This is paid forby company debit card. Such payments are generally seen to leave the company account on the nextworking day.

(d) Five new computers will be ordered over the Internet on 5 January at a total cost of £6,500. A cheque willbe sent out on the same day. The amount will leave Cleanly Ltd’s bank account on the second day followingthis (excluding the day of posting).

(5) Other informationThe balance on Cleanly’s bank account will be £200,000 on 2 January 2006. This represents both the bookbalance and the cleared funds.

Required:

Prepare a cleared funds forecast for the period Monday 2 January to Friday 6 January 2006 inclusive using theinformation provided. Show clearly the uncleared funds float each day.

(20 marks)

4

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3 Fibre Clean Ltd is a small company specialising in the cleaning of upholstery and carpets. All of the company’s currentcustomers are domestic and pay at the time the work is done. Mr Sykes, the owner, is considering undertaking anumber of commercial contracts instead of his domestic work because the profit margins are much higher. It isstandard practice in this sector to offer 30-day credit terms to customers. Mr Sykes is concerned about a number ofissues. Firstly, how he can ensure that he only provides credit to creditworthy customers. Secondly, how he willmanage the extra administrative workload and, finally, what the effect of providing credit will be on his cash position.He is already overdrawn at his local bank.

A friend of Mr Sykes has suggested that he should obtain ‘trade references’ for his new customers and seek the adviceof a ‘credit reference agency’.

Required:

(a) Describe the following sources of externally generated information and their usefulness in assessing thecreditworthiness of Mr Sykes’ new customers:

(i) Trade reference;(ii) Credit reference agency. (6 marks)

(b) Explain the meaning of ‘debt factoring’ and ‘invoice discounting’ to Mr Sykes. Highlight any key differencesbetween the two and suggest which one may be more useful for Mr Sykes. (5 marks)

(c) If Mr Sykes changes to commercial contracts, he expects sales for the next year to be £75,000, with customerspaying within the 30-day limit set. It would cost him £2,000 per annum to employ someone one day a week toinvoice customers and collect debts for him. Alternatively, his local bank has offered to provide a factoring servicefor him, including the advance of 80% of his sales invoices. They would charge 2% of turnover for theadministration and charge interest of 8% per annum on advances. However, the bank would not invoice Mr Sykes’ customers. He would need to employ somebody for half a day a week to do this, at a cost of £1,000per annum.

Mr Sykes pays interest at the rate of 10% per annum on his overdrawn bank account.

Mr Sykes thinks that customers will pay within 30 days regardless of which option is selected.

Required:

Calculate and recommend whether or not Mr Sykes should factor his debts. (9 marks)

(20 marks)

5 [P.T.O.

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4 (a) Define the term ‘financial intermediary’, distinguishing between a ‘broker’ and a ‘principal’. Give fourexamples of organisations that act as financial intermediaries. (4 marks)

(b) Discuss four main benefits of financial intermediation. (8 marks)

(c) Briefly describe four main money market instruments. (4 marks)

(d) Governments use monetary policy to control prices, economic growth and employment levels.

Required:

Define ‘quantitative’ and ‘qualitative’ controls used by governments. (4 marks)

(20 marks)

End of Question Paper

6

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2005 Answers

1 Gold Club Ltd

(a) Time0 1 2 3 4 5 6

£’000 £’000 £’000 £’000 £’000 £’000 £’000Market research – ignoreMembership fees (notes 1 & 2) 2,500 3,500 3,500 3,500 3,500Set-up costs (note 3) (375) (1,125)Maintenance costs (note 4) (100) (120) (144) (173) (208)Club cards (5,000 x £3) (15) (15) (15) (15) (15)First Class lounge (note 5) (200) (300) (300) (300) (300)Travel insurance (note 6) (270) (420) (435) (450) (465)Upgrade costs (10 x £100k) (1,000) (1,000) (1,000) (1,000) (1,000)Interest costs – ignore

–––––– –––––– –––––– –––––– –––––– –––––– ––––––Net cash flow (375) (1,125) 915 1,645 1,606 1,562 1,512

–––––– –––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– –––––– ––––––

10% discount factors 1·000 0·909 0·826 0·751 0·683 0·621 0·564–––––– –––––– –––––– –––––– –––––– –––––– ––––––

Discounted cash flow (375) (1,023) 756 1,235 1,097 970 853–––––– –––––– –––––– –––––– –––––– –––––– ––––––

The net present value of the project is £3·513 million. The project should therefore be undertaken, since the net present valueis positive.

Note 1: Membership numbers Year 1 Year 2 Year 3 Year 4 Year 5T2 T3 T4 T5 T6

New members 5,000 5,000 5,000 5,000 5,000Renewals at 50% 2,500 2,500 2,500 2,500

–––––– –––––– –––––– –––––– ––––––Total members 5,000 7,500 7,500 7,500 7,500

–––––– –––––– –––––– –––––– ––––––Of which, new members 5,000 5,000 5,000 5,000 5,000

–––––– –––––– –––––– –––––– ––––––Renewals 0 2,500 2,500 2,500 2,500

–––––– –––––– –––––– –––––– ––––––

Note 2: Fees Year 1 Year 2 Year 3 Year 4 Year 5T2 T3 T4 T5 T6

New members 5,000 5,000 5,000 5,000 5,000Fee per member £ 500 500 500 500 500

£’000 £’000 £’000 £’000 £’000Total new member fees 2,500 2,500 2,500 2,500 2,500

–––––– –––––– –––––– –––––– ––––––Renewal member numbers 0 2,500 2,500 2,500 2,500Fee per member £ 400 400 400 400 400

£’000 £’000 £’000 £’000 £’000Total fees from renewals 0 1,000 1,000 1,000 1,000

–––––– –––––– –––––– –––––– ––––––Total fees 2,500 3,500 3,500 3,500 3,500

–––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– ––––––

Note 3: Set-up costs

Costs = £1,220k + £125k + £155k = £1,500k

T0: 25% x £1,500k = £375kT1: 75% x £1,500k = £1,125k

Note 4: Maintenance costs Year 1 Year 2 Year 3 Year 4 Year 5£’000 £’000 £’000 £’000 £’000

T2 T3 T4 T5 T6£100k in first year 100Increasing by 20% each year thereafter 120 144 173 208

–––––– –––––– –––––– –––––– ––––––

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Note 5: First Class lounge Year 1 Year 2 Year 3 Year 4 Year 5T2 T3 T4 T5 T6

Number of members 5,000 7,500 7,500 7,500 7,500–––––– –––––– –––––– –––––– ––––––£’000 £’000 £’000 £’000 £’000

40% x £20 x 3 120 180 180 180 18030% x £20 x 2 60 90 90 90 9020% x £20 x 1 20 30 30 30 30

–––––– –––––– –––––– –––––– ––––––Total costs 200 300 300 300 300

–––––– –––––– –––––– –––––– ––––––(There is effectively an average of two visits per club member per year.)

Note 6: Travel insurance costs Year 1 Year 2 Year 3 Year 4 Year 5T2 T3 T4 T5 T6

Flat rate per member £ 50 52 54 56 58E-mail costs: 2 x £2 4 4 4 4 4

–––––– –––––– –––––– –––––– ––––––54 56 58 60 62

–––––– –––––– –––––– –––––– ––––––Total number of members 5,000 7,500 7,500 7,500 7,500

£’000 £’000 £’000 £’000 £’000–––––– –––––– –––––– –––––– ––––––

Total costs 270 420 435 450 465–––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– ––––––

(b) Venture capitalists

Factors that a venture capitalist organisation will take into account are as follows:

(i) Level of expertise of Gold Club Ltd’s managementVenture capitalists will believe that the success of Gold Club Ltd’s membership scheme is dependent on the quality ofthe two shareholders/directors. They will expect these two key personnel to show a high level of commitment to theproject. As both the existing owners of the business are all involved in the running of the company, this should be proofof their commitment. The venture capitalists will also look at the amount of money that the owners themselves haveinvested in the project in assessing their level of commitment. The venture capitalists will expect a place on Gold ClubLtd’s Board of Directors so that they can have a say in future business strategy.

(ii) Level of expertise in the area of serviceThe venture capitalists will seek assurance that the directors have the necessary know-how and technical support to beable to run the website properly. In addition, they will need assurance that Gold Club Ltd can really provide the servicesto its customers.

(iii) The nature of Gold Club Ltd’s productThe venture capitalists will consider the feasibility of providing the service at the membership prices proposed. This willinvolve analysing the cost estimates to ascertain their accuracy and ensuring, for example, that key airlines have agreedto the discounted upgrades and to the use of their First Class lounges. The venture capitalists will need a high level ofassurance about the accuracy of the forecast membership numbers.

(iv) The market and competitionThe venture capitalists will seek assurance that there is actually a market for the Club, as there are already some similarmemberships available in the market place. They will ask to see the market research that has already been carried out.The venture capitalists will also look at the threat posed by new entrants in the market, and current rival membershipschemes.

(v) Future prospectsSince the risk involved in investing in a new company is fairly high, the venture capitalists will seek to ensure that theprospects for future profits compensate for the risk. They will therefore want to see a detailed business plan setting outthe future business strategy.

(vi) Exit routesThe venture capitalists will consider potential exit routes before they invest in the venture. They will not invest money ina share of the business unless they are confident that it can be sold at some point in the future.

Note: Only five factors were required.

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2 Cleanly Ltd

Cleared Funds Forecast2 Jan 3 Jan 4 Jan 5 Jan 6 Jan

£ £ £ £ £ReceiptsW Ltd 130,000 0 0 0 0X Ltd 0 0 0 180,000 0

–––––––– –––––––– –––––––– –––––––– ––––––––130,000 0 0 180,000 0–––––––– –––––––– –––––––– –––––––– ––––––––

PaymentsA Ltd 45,000 0 0 0 0B Ltd 0 0 75,000 0 0C Ltd 0 0 95,000 0 0Wages 0 0 0 0 12,000Salaries 56,000 0 0 0 0Petty Cash 200 0 0 0 0Stationery 0 0 300 0 0

–––––––– –––––––– –––––––– –––––––– ––––––––101,200 0 170,300 0 12,000–––––––– –––––––– –––––––– –––––––– ––––––––

Cleared excess receiptsover payments 28,800 0 (170,300) 180,000 (12,000)Cleared balance b/f 200,000 228,800 228,800 58,500 238,500

–––––––– –––––––– –––––––– –––––––– ––––––––Cleared balance c/f 228,800 228,800 58,500 238,500 226,500

–––––––– –––––––– –––––––– –––––––– ––––––––

Uncleared funds floatReceipts 180,000 180,000 180,000 0 0Payments (170,000) (170,300) 0 (6,500) (6,500)

–––––––– –––––––– –––––––– –––––––– ––––––––10,000 9,700 180,000 (6,500) (6,500)

–––––––– –––––––– –––––––– –––––––– ––––––––Total book balance c/f 238,800 238,500 238,500 232,000 220,000

–––––––– –––––––– –––––––– –––––––– –––––––––––––––– –––––––– –––––––– –––––––– ––––––––

3 Fibre Clean Ltd

(a) (i) Trade referenceA trade reference is a reference received from another business that the potential customer deals with. The trade refereeselected should offer similar terms to those now being offered to Mr Sykes’ customers, that is, 30-days terms.

A well known company stated as a referee should always be followed up, but if the name given is that of an unknowncompany, it should be treated with caution. This is because there is an increased likelihood of collusion between MrSykes’ new customer and their referee. Mr Sykes should contact the referee himself, enclosing a stamped addressedenvelope so that the reply comes direct to him. This prevents possible alteration by the customer.

The main problem with obtaining trade references arises from the fact that Mr Sykes’ potential customers are unlikelyto provide him with the names of referees who will provide bad references. They will only provide the names of thosecreditors with whom they have a good credit history. Their usefulness is severely limited by this factor.

(ii) Credit reference agencyThese agencies provide information about businesses so that their creditworthiness can be assessed by potentialsuppliers. The level of information they hold varies. Some merely hold background information, for example, a set of acompany’s financial statements. Others hold more up to date information and may offer a credit rating.

Some of the main agencies include Equifax, Infolink, CCN, Moody’s and Dunn & Bradstreet.

The main restriction on the usefulness of these agencies is that the information is often out of date. They are also of lessuse for assessing newer businesses which do not have enough history on which to base a credit assessment.

(b) Debt Factoring and Invoice Discounting

Debt Factoring‘Debt Factoring’ is a service provided by factors whereby the factor collects debts on behalf of their client and often invoicestheir client’s customers as well. The factor also advances, to its client, a proportion of the money it is due to collect (typicallyabout 80% is advanced).

Mr Sykes would find the service useful because he could both receive cash early and reduce administration.

11

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There are two types of factoring agreements: ‘with recourse’ and ‘without recourse’ agreements. With the first of theseagreements, although the factor advances monies, the risk of non-payment of debts stays with the client. If a debtor defaults,the factor has ‘recourse’ to their client for the money. If the agreement is ‘without recourse’ the factor bears the risk of non-payment.

Debt factoring has to be paid for, usually as a percentage of the amounts advanced and as a percentage of turnover.Agreements without recourse to the client obviously cost more. Mr Sykes would have to compare his total costs if he uses afactor to his total costs if he does not use a factor before making a decision. He should also take into account the fact thatthere is some stigma attached to debt factoring as clients sometimes assume that a business using a factor must be infinancial difficulty.

Invoice DiscountingInvoice discounting is a service whereby a provider (often a factoring company) purchases invoices from a client at a discount.In this case, they are merely advancing cash, rather than providing a debt collection service.

Again there will be a charge for discounting, calculated as a percentage of the invoices purchased.

Given Mr Sykes’ concerns about his increased workload, a factoring arrangement would be far more suited to his needs.

(c) Cost of factoringCost of financing debtors £ £Average debtors £75,000 x 30/365 6,16420% financed by overdraft at 10% 123Average level of factor’s advance:£6,164 x 80% 4,931Cost at 8% 394

––––––Total cost of financing debtors 517Sales administration cost2% x £75,000 1,500Invoicing administrator employed 1,000

––––––Total cost of arrangement 3,017

––––––

Cost of not factoringCost of financing debtorsAverage debtors £75,000 x 30/365 6,164Financed by overdraft at 10% 616Sales administration costNew staff 2,000

––––––Total cost of arrangement 2,616

––––––

The factoring arrangement would cost Mr Sykes £401 per annum more than not factoring. Therefore, he should not enterinto the agreement.

4 Financial matters

(a) Financial intermediariesA financial intermediary is an organisation that brings together potential borrowers and potential lenders. Such anintermediary can act as a broker, whereby they handle a transaction on behalf of others. Alternatively, they may act as aprincipal, whereby they hold money balances of lenders for lending on to borrowers.

Examples of financial intermediaries include:– Banks– Building societies– Finance houses– Insurance companies– Pension funds– Unit trusts– Investment trust companies

Note: Only four examples were required.

(b) Benefits of financial intermediation

(i) Lending/borrowing becomes easierThe intermediary has a whole range of lenders and a whole range of borrowers. This makes lending and borrowingeasier. Both parties know where to go to lend or borrow money since the services of financial intermediaries are well-advertised.

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(ii) Risk reductionThe intermediary helps to spread the risk of lending money to borrowers among the various lenders who deposit moneywith the intermediary. This clearly benefits the lender.

In addition, intermediation reduces risk for the borrower too. For example, an organisation such as a unit trust companyinvests money in a variety of stocks and shares thereby ensuring diversification. Individuals then buy a small share ofsuch investments, thus benefiting from risk reduction through diversification, but without having to invest large sums ofmoney in numerous investments.

(iii) AggregationThe intermediary is able to aggregate the amount lent by savers into amounts which the borrower may require. Thismakes the process of borrowing large sums of money much easier for the borrower. For example, if an individualrequiring £100,000 to buy a house had to approach numerous different lenders, the process would be time-consumingand expensive.

(iv) Maturity transformationThe intermediary bridges the gap between the desire of many lenders for liquidity and the need of many borrowers forlong-term loans. In order to fulfil this role, it is essential that the intermediary keeps an adequate reserve of liquid assets.

(c) Financial instruments– Deposits: deposits of money with financial intermediaries such as banks.

– Bills: short-term financial assets which can be converted into cash at short notice by selling them in the discount market.

– Commercial paper: short-term IOUs issued by large companies. They can either be held until maturity or sold on beforethen.

– Certificates of deposit: available to customers who deposit a minimum of £50,000 for fixed terms. They can be helduntil maturity or sold in the CD market.

(d) Monetary policies

Quantitative controlsQuantitative controls are those controls introduced by the government to restrict the amount of money lent by the clearingbanks.

Qualitative controlsThese are where the government restricts the type of lending that banks can do, rather than the amounts which they canlend. For example, the government may introduce incentives for lending to manufacturing businesses, or create disincentivesfor lending to individuals.

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2005 Answers

Marks1 Gold Club Ltd

(a) NPVIgnore market research 2Membership numbers 2Membership fees 4Set-up costs 2Maintenance costs 1Club cards 1First class lounge 4Travel insurance 3Upgrade costs 1Ignore interest costs 1Net cash flow 2Correct discount factors 1Discounted cash flow 2NPV 1Conclusion and reason 2Presentation 1

––––Total 30

––––

(b) Venture capitalistsFor each factor discussed 2

––––Max marks 10

––––Total marks 40

––––

2 Cleanly Ltd

Receipts:W Ltd 1X Ltd 1

Payments:A Ltd 1B Ltd 1C Ltd 1Wages 1Salaries 1Petty Cash 1Ignore window cleaner 1Stationery 1Total 1

Cleared excess 1Cleared balance b/f 2Cleared balance c/f 1

Uncleared funds floatReceipts 1Payments 1

Total book balance c/f 1Correct presentation 2

––––Total marks 20

––––

15

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Marks3 Fibre Clean Ltd

(a) References and agencies

(i) Trade referenceDefinition 1Similar terms 1Well known co. vs unheard of 1Contact directly 1Limitation 1

––––Max marks 3

––––

(ii) Credit reference agencyProvide info re suppliers 1Detail of info varies 1Main agencies 1Out of date 1Not good for new companies 1

––––Max marks 3

––––

(1 mark each awarded for any useful comments)

(b) Factoring and invoicingFactoringDefinition 1Includes administration 1With recourse agreements 1Without recourse agreements 1Cost 1

Invoice discountingDefinition 1Advancing cash 1Cost 1Conclusion on most suitable 1

––––Max marks 5

––––

(c) Cost of factoringFactoringAverage debtors figure 120% overdraft cost 180% advance figure 1Cost at 15% 1Sales admin cost at 2% 1Invoicer cost 1

Not factoringOverdraft cost at 100% 1Administrator cost 1

Conclusion 1––––

Total 9––––

Total marks 20––––

16

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Marks4 Financial matters

(a) Financial intermediariesDefinition 1Broker/principal 1Examples 2(0·5 each, max 2 marks)

––––Total 4

––––

(b) BenefitsEasier 2Risk reduction 2Aggregation 2Maturity transformation 2

––––Total 8

––––

(Award marks for all sensible points)

(c) Financial instrumentsEach one 1

––––Total 4

––––

(d) Monetary policiesQuantitative controls 2Qualitative controls 2

––––Total 4

––––Total marks 20

––––

17

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Managing Finances

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

ADVANCED LEVEL

WEDNESDAY 14 JUNE 2006

QUESTION PAPER

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examinationhall

The Association of Chartered Certified Accountants

Pape

r T1

0

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ALL FOUR questions are compulsory and MUST be attempted

1 Maybay Hospital is a private hospital. Currently, all cleaning is undertaken by staff employed by the hospital. Thereare 150 cleaning staff in total, of which half work full-time and half work part-time.

Over the last year there has been a serious outbreak of the MRSA bug (a bacterial infection resistant to antibiotics) inthe hospital. Cleaning standards have therefore become a key issue. The hospital is currently being sued by a groupof patients who are all claiming to have suffered from MRSA following admittance to Maybay. This has caused asignificant fall in the number of patient admissions and an increase in the hospital’s insurance costs.

The hospital managers are now considering whether they should continue with their existing cleaning staff (Option 1)or contract out the cleaning function to external providers for the next five years (Option 2). The following informationhas been provided:

1 Full-time cleaning staff work 35 hours a week and are paid £5·70 per hour. 2 Part-time cleaning staff work a 20-hour week and are paid £5·65 per hour.3 Eight full-time supervisors are also employed, in addition to the cleaning staff, at a salary of £15,000 per annum

each.4 Other staff costs, including pension costs, average £2,625 per annum per full-time employee (including

supervisors) and £1,215 per part-time employee.5 If the cleaning continues to be done by hospital cleaners, it has already been decided that 10 new full-time

cleaners will be employed immediately. The hospital will also recruit a further 15 full-time cleaners in one year’stime.

6 Total insurance costs for the whole hospital are currently £6·5 million per annum. The hospital estimates thatthese will fall immediately by 10% if the cleaning is contracted out to an external provider. They will remain thesame if the cleaning is NOT contracted out.

7 Cleaning materials cost £1·44 million per annum. If an external provider is used in the future, they will providetheir own cleaning materials.

8 Independent inspectors inspect hospital hygiene standards every six months. Breaches of standards fall into oneof two categories: serious breaches, for which a fine of £10,000 per breach is imposed, and minor breaches, forwhich a fine of £2,000 per breach is imposed. If the hospital does NOT contract out its cleaning, but the newcleaners are employed, it is estimated that serious breaches can be limited to 22 per year and minor breachescan be limited to 74 per year. The external providers expect to restrict these breaches to 17 and 50 respectivelyin the first year, falling to 8 and 25 respectively per year thereafter. Even with a contracted out cleaning service,the hospital will continue to be responsible for all payments of fines.

9 The hospital has invested heavily in floor polishing machines over recent years, and currently has 150 in total.The external providers have offered to buy these immediately at a price of £4,000 each, should the contractingout go ahead.

10 Adverse publicity resulting from the MRSA bug is costing the hospital £1·2 million per annum in lost contribution.The external cleaning providers’ reputation is such that this amount can be totally eliminated immediately.

11 The external providers have offered to provide cleaning services for a contracted five-year period. The fees will be£4·25 million for each of the first two years, increasing to £4·5 million per annum thereafter.

12 Administration costs are currently £300,000 per annum. They would fall to £270,000 per annum if the cleaningwere contracted out.

13 If the hospital decides to contract out the cleaning, it will be with immediate effect. A redundancy package hasbeen put together for current staff. Each full-time employee, including supervisors, will receive an average of£5,000 and each part-time employee will receive an average of £3,000. These amounts will be payableimmediately.

14 The hospital managers have spent £60,000 researching and calculating their costs.15 The hospital’s cost of capital is 10% per annum.16 Assume that all cash flows occur at the end of each year unless told otherwise.

2

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Required:

(a) Calculate the net present values of the costs of each of the two options above. Recommend whether thehospital should continue with its existing staff (Option 1) or contract out of cleaning for the next five years(Option 2). (30 marks)

(b) State four factors, other than cost, that should be taken into account when deciding whether to use theexternal providers. (4 marks)

(c) Explain the main principles used to differentiate between relevant and irrelevant costs for investmentappraisal. Include a brief explanation of the treatment of finance costs. (6 marks)

NOTE: All workings and answers should be in £’000, to the nearest £’000.

Present value table (extract)Periods (n) Discount rate (r)

10%1 0·9092 0·8263 0·7514 0·6835 0·621

Annuity factor table (extract)Periods (n) Discount rate (r)

10%1 0·9092 1·7363 2·4874 3·1705 3·791

(40 marks)

3 [P.T.O.

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2 You have been provided with the following financial information relating to Health Foods Ltd.

Forecast Profit and Loss Account for the year ending 30 June 2007

£’000Turnover 20,350Operating costs (12,265)

–––––––Operating profit 8,085Interest payable (785)

–––––––Profit before tax 7,300Tax payable (2,230)

–––––––Profit after tax 5,070Dividends payable (2,270)

–––––––Retained profit 2,800

–––––––

Extract from Historical Balance Sheet as at 30 June 2006 (Actual figures)

£’000 £’000 £’000Fixed assets 8,000Current assetsStock 2,167Debtors 2,543Cash 1,264

––––––5,974

Current liabilitiesTrade creditors 1,737Tax payable 1,895Dividends payable 1,542

––––––(5,174)––––––

Net current assets 800––––––

Net assets 8,800––––––––––––

Extract from Forecast Balance Sheet as at 30 June 2007

£’000 £’000 £’000Fixed assets 8,300Current assetsStock 3,245Debtors 3,318Cash 2,984

––––––9,547

Current liabilitiesTrade creditors 1,723Tax payable 2,289Dividends payable 2,235

––––––(6,247)––––––

Net current assets 3,300–––––––

Net assets 11,600––––––––––––––

4

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Additional information1. Operating costs include depreciation of £200,000.2. The company does not plan to sell any fixed assets over the next year.3. Fixed assets are all tangible (physical) assets.4. All finance costs are paid in the year in which they are incurred.

Required:

(a) Prepare a forecast cash flow statement for Health Foods Ltd for the year ending 30 June 2007 identifyingthe net cash flow for the business.Note: Accounting standards format is not required. (16 marks)

(b) Briefly describe the drawbacks of the Baumol (EOQ) cash management model. (4 marks)

(20 marks)

5 [P.T.O.

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3 You are an accounting technician working at Shoes for You Ltd, a company that manufactures and distributes a rangeof fashion shoes. All shoes are made at the company’s factory in the country of Bushai, where materials and labourhave historically been very cheap. The shoes are then exported to the UK where they are sold to a number of retailoutlets.

All costs are incurred in Bushai’s unit of currency. All materials are paid for in cash at the time of purchase. Productionstaff are paid their wages daily in cash. They have not had a pay increase in the last year. All other overheads,production and sales, are on credit.

All sales are to UK customers and are on credit. They are, therefore, invoiced (and amounts are received) in £ sterling.Any finance needed for the business is also obtained from the UK.

You have estimated the figures below for the coming year. Sterling has been used for all figures so as to avoid anydistortion caused by high inflation in Bushai.

Sales £2,500,000Average debtors £410,000Materials purchases £630,000Production staff wages £450,000Other production overheads £350,000Sales overheads £320,000Net profit margin 30%Average stocks:Finished goods £325,000Work in progress (65% complete) £195,000Raw materials £133,000Average creditors £73,000

The economy in Bushai has recently become unstable. This has led to a rapid increase in inflation levels over the lastyear, from 10% at the beginning of the year to 25% at the end of the year. Interest rates are controlled by Bushai’scentral bank. Inflation in the UK has remained stable at about 4% per annum.

Required:

(a) Calculate the cash operating cycle. (10 marks)

(b) The raw material holding period has doubled over the last year.

State the main financial advantage and main financial disadvantage of this happening, paying attention tothe fact that inflation has increased over the year. (4 marks)

(c) Discuss BRIEFLY the general problems associated with inflation as listed below and consider how eachproblem affects Shoes for You Ltd.

(i) Redistribution of income and wealth; (2 marks)

(ii) The balance of trade (Do NOT discuss exchange rates); (2 marks)

(iii) Higher interest rates. (2 marks)

(20 marks)

6

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4 Financial analysts will use ratios to compare performance of companies in the same industry.

Lenders will frequently use ratio analysis to help them decide whether to lend to an individual in the first place andwhether to continue their financial support. Business owners and managers also use ratios to assess the financialperformance of their business. Such ratios may include earnings per share, interest cover, gearing and net profitmargin.

Required:

(a) Outline FOUR sources of finance (short and/or long-term) available to small and medium-sized businesses.Ignore government grants, leasing and factoring. (12 marks)

(b) Discuss four limitations of ratio analysis. (8 marks)

(20 marks)

End of Question Paper

7

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2006 Answers

1 Maybay Hospital

(a) Option 1: Continue with existing staff Time0 1 2–5

£’000 £’000 £’000Full-time staff costs (1) 1,246 1,440Part-time staff costs (2) 532 532Cleaning materials 1,440 1,440Insurance costs 6,500 6,500Fines (3) 368 368Administration costs 300 300Research costs – ignore as sunk

––––– ––––––– –––––––Net cash flow 0 10,386 10,58010% discount factors (4) 1·000 0·909 2·882Discounted cash flow 0 9,441 30,492

––––– ––––––– –––––––––––– ––––––– –––––––

Total present value of costs of Option 1 over next five years is £39·933 million.

T1 T2–51. Full-time staff costs £’000 £’000

Wages: 85/100 staff x 35hrs at £5·70 x 52 weeks 882 1,037Supervisors: 8 x £15,000 120 120Other costs: £2,625 x 93/108 244 283

–––––– ––––––1,246 1,440

–––––– ––––––

2. Part-time staff costs T1–5Wages:75 staff x 20hrs at £5·65 x 52 weeks 441Other costs: £1,215 x 75 91

––––532––––

3. FinesSerious breaches (22 x £10,000) 220Minor breaches (74 x £2,000) 148

––––368––––

4. Annuity factorAnnuity factor T2 – T5 = 3·791 – 0·909 = 2·882

Option 2: Contracting out Time0 1 2 3–5

£’000 £’000 £’000 £’000Annual contract fees 4,250 4,250 4,500Revised insurance costs (£6·5m x 90%) 5,850 5,850 5,850Revised fine costs (5) 270 130 130Machine sales (150 x £4000) (600)Saved revenue contribution (1,200) (1,200) (1,200)Administration costs 270 270 270Redundancy costs (6) 640

–––––– –––––– –––––– –––––––Net cash flow 40 9,440 9,300 9,550

–––––– –––––– –––––– ––––––––––––– –––––– –––––– –––––––10% discount factors (7) 1·000 0·909 0·826 2·055

–––––– –––––– –––––– –––––––Discounted cash flow 40 8,581 7,682 19,625

–––––– –––––– –––––– ––––––––––––– –––––– –––––– –––––––

Net present value of costs of Option 2 is £35·928 million.The hospital should therefore choose Option 2 and contract out the cleaning since the net present value of the costs is£4·005 million less than for Option 1.

11

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Yr 1 Yrs 2–55. Revised fines £’000 £’000

Serious breaches (17/8 x £10,000) 170 80Minor breaches (50/25 x £2,000) 100 50

–––– ––––270 130–––– ––––

6. Redundancy costsFull-time: 83 x £5,000 415Part-time: 75 x £3,000 225

––––640––––

7. Annuity factorAnnuity factor T2 – T5 = 3·791 – 1·736 = 2·055

Note: It is the difference in the NPVs of the two options that is important, rather than the NPVs themselves.

(b) Other factorsOther factors to be considered, apart from cost:

(i) The experience of the external provider’s cleaners in the area of hospital cleaning.(ii) The reliability of the cleaners in turning up for work.(iii) The quality of the cleaning provided.(iv) The effect on morale of remaining hospital staff if work is passed on to an outside provider and redundancies are made.(v) The extent to which reliance can be placed on the external provider’s assertions re reducing fines and lost admissions.(vi) The extent to which the cleaning materials used by the contractors are environmentally friendly.

Note: Only four factors were required. Marks will be given for any sensible suggestion.

(c) Relevant costsThe following principles should be applied when identifying costs that are relevant to a project.

Relevant costs are future costsA relevant cost is a future cost arising as a direct consequence of a decision. A cost which has been incurred in the past istherefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’.

Relevant costs are cash flowsOnly those future costs which are in the form of cash should be included. This is because relevant costing works on theassumption that profits earn cash.

Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making.

Relevant costs are incremental costsA relevant cost is the increase in costs which results from making a particular decision. For example, an opportunity cost –the value of a benefit foregone as a result of choosing a particular course of action – will always be a relevant cost. This isbecause it is a future incremental cost.

Any costs or benefits arising as a result of a past decision should be ignored, for example, costs to which the business isalready committed.

Finance costsCertain other costs will also be irrelevant to decision-making, such as ‘finance costs’. This is because interest has alreadybeen taken into account in the discounting process.

2 Health Foods Ltd

(a) Projected cash flow statement £’000Operating profit 8,085Depreciation 200Finance costs (785)Tax paid (w.1) (1,836)Dividends paid (w.2) (1,577)Fixed asset purchases (w.3) (500)Increase in stock (w.4) (1,078)Increase in debtors (w.5) (775)Decrease in trade creditors (w.6) (14)

––––––Projected increase in cash over the year 1,720

––––––

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Reconciled as follows: £’000Cash per BS at 30/06/06 (1,264)Cash per BS at 30/06/07 2,984

––––––Projected increase in cash over the year 1,720

––––––

Workings

1. Tax paid £’000Tax payable b/f at 01/07/06 (1,895)Tax charge for y/e 30/06/07 (2,230)Tax payable c/f at 30/06/07 2,289

––––––Therefore cash paid (1,836)

––––––

2. Dividends paidDividends payable b/f at 01/07/06 (1,542)Dividend charge for y/e 30/06/07 (2,270)Dividends payable c/f at 30/06/07 2,235

––––––Therefore cash paid (1,577)

––––––

3. Fixed asset purchasesFixed assets b/f at 01/07/06 8,000Depr’n charge for y/e 30/06/07 (200)Fixed assets at 30/06/07 (8,300)

––––––Therefore cash paid (500)

––––––

4. Increase in stockStock as at 30/06/07 3,245Stock as at 30/06/06 (2,167)

––––––Increase 1,078

––––––

5. Increase in debtorsDebtors as at 30/06/07 3,318Debtors as at 30/06/06 (2,543)

––––––Increase 775

––––––

6. Decrease in trade creditorsTrade creditors as at 30/06/07 1,723Trade creditors as at 30/06/06 (1,737)

––––––Decrease (14)

––––––

Note: full marks given for any method of arriving at projected increase in cash over the year. An example of anotherapproach is summarised below

£’000Receipts (20,350 + 2,543 – 3,318) 19,575Payments for operating expenses(12,265 – 1,723 + 1,737 – 200 + 3,245 – 2,167) (13,157)Interest paid (785)Tax paid (w.1) (1,836)Dividends paid (w.2) (1,577)Fixed asset purchases (w.3) (500)

–––––1,720–––––

(b) Drawbacks of Baumol model

1. It does not take into account costs associated with running out of cash.

2. The model only works properly for a firm which uses up cash at a steady rate throughout the year. In practice, mostfirms are likely to have large inflows or outflows of cash from time to time.

3. In practice, it will be difficult to predict future cash requirements with certainty.

4. Future interest rates are difficult to estimate.

5. It assumes that transaction costs are constant but, in practice, they may vary.

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3 Shoes For You Ltd

(a) DaysRaw materials stock period: Raw materials 133,000–––––––––––– x 365 = ––––––––– x 365 77Purchases 630,000

Credit taken from suppliers:Creditors 73,000––––––––––––––––––– x 365 = ––––––––– x 365 (40)Credit overheads (w.1) 670,000

Work in progress:Work in progress 195,000––––––––––––––––––––––––––––––––––– x 365 = –––––––––––––––– x 365 77Cost of sales (w.2) x degree of completion 1,430,000 x 65%

Finished goods:Finished goods 325,000––––––––––––– x 365 = –––––––––– x 365 83Cost of sales 1,430,000

Credit allowed to debtors:Debtors 410,000–––––– x 365 = –––––––––– x 365 60Sales 2,500,000

––––257––––––––

The cash operating cycle is therefore approximately 257 days.

Working 1: Credit overheads £

Production overheads 350,000Sales overheads 320,000

––––––––––Costs on credit 670,000

––––––––––

Working 2: Cost of sales Materials 630,000Wages 450,000Production overheads 350,000

––––––––––Cost of sales 1,430,000

––––––––––

(b) Increase in raw material holding periodAdvantage – Since prices are increasing, it makes sense to buy more raw materials before prices increase even more. Overallpurchase costs will therefore be lower.

Disadvantage – Stock holding costs will increase. These include the costs of working capital tied up in stock, warehousingcosts and deterioration costs.

(c) The general problems associated with inflation

(i) Redistribution of income and wealthInflation will lead to a redistribution of income and wealth. This is because debts, for example, lose their real value withinflation. This kind of random redistribution is undesirable as those in positions of economic power tend to gain at theexpense of others.

In Shoes For You Ltd’s case, however, their income is received in sterling. Since this is a stable currency the value ofthe company’s debts is not decreasing much in real terms.

(ii) The balance of trade may sufferIf a country has a higher rate of inflation compared to that of the countries it trades with, then its exports become moreexpensive for its overseas partners and its imports become cheaper for its residents. This affects the balance of tradeadversely.

In the case of Shoes For You Ltd, the reason the shoes are made in Bushai is because of relatively low materials andlabour costs. Whilst production labour costs are not yet increasing because of fixed wages, materials costs are alreadyincreasing dramatically and it may soon become cheaper to set up a factory elsewhere. In the long-term, labour costswill have to increase as well otherwise workers will presumably seek employment elsewhere.

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(iii) Higher interest ratesThe central bank in Bushai may counter inflation by raising interest rates. This makes the cost of borrowing higher andtherefore limits investment opportunities. Since all the finance for Shoes For You Ltd is obtained from the UK, thisproblem will not affect Shoes For You Ltd.

4 Sources of finance

(a) Sources of finance for SMEs

EquityWhen the business is first set up, the first (probably main) source of finance will be equity injected by the owner, and possiblyby family and friends. The owner may have to re-mortgage his home to obtain funds.

Since the business will have few tangible assets at this stage, it will be difficult to obtain equity from elsewhere.

Once the business becomes more established, equity finance will become more readily available. Shares can be sold privatelyto investors. Since equity owners also have the right to participate in the running of the business, through voting, the initialowner may wish to sell a small number of shares to a number of investors so as to maintain control.

Overdrafts An overdraft is a deficit on a bank current account.

Overdrafts are suitable for short-term borrowing only. This is because they are usually expensive, both in terms of arrangementfees and in terms of interest charges. Also, they are repayable on demand. This means that the bank can withdraw the facilityat any time, usually at a time when the business most needs the cash because of financial difficulties.

Although overdrafts are not suitable for long term borrowing, they are often used as a permanent source of finance.

LoansIf an overdraft appears to be becoming too permanent, the bank may suggest that it is converted into a medium term loan.In this way, the business is forced to start repaying some of it.

The bank may also provide loans for the purchase of fixed assets or for expansion of the business.

In general terms, overdrafts are more suitable for the financing of working capital and loans are more suitable for longer termassets or projects.

Trade creditTrade credit is often used as a source of finance for small and medium-sized enterprises (SMEs), particularly when thebusiness is first starting up. Ironically, this is the time when such finance can be difficult to obtain, due to lack of thebusiness’s reputation and credit history.

The cost of trade finance has to be weighed up, taking into account both loss of early payment discounts and loss of suppliergoodwill.

Business angel financingBusiness angels may be either individuals or groups of individuals. They are characterised by their wealth! Such forms offinancing tends to be informal and it is very much a question of knowing the right people.

The informal nature of this type of financing can be both a strength and a weakness. It is a strength because many of theonerous formalities relating to provision of information to financiers are avoided. However, it is a weakness because of thelack of a formal business angel market through which finance can be sought.

Venture capitalVenture capitalists tend to invest in new businesses and specific expansion schemes. They tend to be attracted to businessesthat will eventually be listed on the stock exchange, both because businesses of this size will generate the largest profits andbecause this also gives them an exit route in the future. Many of the smaller SMEs will simply not be big enough for venturecapital finance. Also, venture capitalists will want to become involved in running the business because of their need to protecttheir investment.

Note: Only four sources were required.

(b) Limitations of ratio analysis

– On their own, ratios do not provide information that can be used to assess a business’s performance. They are onlyuseful when comparative figures are also available, whether these be budgeted figures, prior year figures, or figures forsimilar companies.

– Where price inflation has occurred, ratios comparing different time periods will not be directly comparable. The wrongconclusions may therefore be drawn about a business’s performance. In order to rectify this, adjustments would haveto be made to allow for price differences.

– Many of the key ratios used actually have numerous different definitions. For example, there are several ways of defininggearing. It is therefore essential to ensure that the exact same definition is being used before ratio analysis is relied upon.

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– When the performance of different companies is being compared, ratios are usually calculated from the companies’financial statements. The problem with this is that these accounts will not have been prepared using exactly the sameaccounting policies. For example, one company may use the straight line method for depreciation whilst the other usesthe reducing balance method. Therefore, once again, inaccurate conclusions may be drawn.

– Ratio analysis is only useful to the extent that key information is readily available. It may be that a business has changedits management accounting system in the year meaning that comparable information is not available in the requiredformat.

– The information on which the ratios are based is historical – not current. A lot might have happened between the datethat the accounts were prepared and the date when they are being analysed.

NOTE: Only four limitations were required.

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2006 Marking Scheme

Marks1 Maybay Hospital

(a) NPV of costsNot contracting out:F/T staff costs 5P/T staff costs 2Cleaning materials 1Insurance costs 1Fines 1Administration costs 1Annuity factor calculation 1Net cash flow 1DCF 2Contractors’ research costs ignored 1Net present value 1

–––Max marks 16

–––

Contracting outAnnual contract costs 1Insurance cost savings 1Revised fine costs 2Lost admissions 1Machine sales 1Reduced administration costs 1Redundancy costs 1Net cash flow 1DCF 2Net present value 1

–––12

–––

Presentation 1Conclusion 1

–––2

–––Total 30

–––

(b) Other factorsEach factor 1

–––Max marks 4

–––

(c) Relevant costsFuture costs 1Cash flows 1Incremental costs 1Opportunity costs 1Committed costs 1Finance costs 1

–––6

–––Total marks 40

–––

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Marks2 Health Foods Ltd

(a) Projected cash flowOperating profit 1Depreciation 1Interest paid 1Tax paid 2Dividends paid 2Fixed asset purchases 2Increase in stock 2Increase in debtors 2Decrease in trade creditors 2Projected cash flow 1

–––16–––

(b) Drawbacks of Baumol modelEach drawback 1

–––Max marks 4

–––Total marks 20

–––

3 Shoes For You Ltd

(a) Cash operating cycleCredit overheads calculation 1COS calculation 2RM days 1Creditor days 1WIP days 2FG days 1Debtor days 1Length of cycle 1

–––10–––

(b) Raw material holding periodAdvantage 2Disadvantage 2

–––4

–––

(c) General problems of inflationRedistribution – max. 2Balance of trade 2Higher interest rates 2

–––Max marks 6

–––(1 mark for each sensible comment, subject to the maximum)Total marks 20

–––

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Marks4 Sources of finance

(a) Sources for SMEsEquity 3Overdrafts 3Loans 3Trade credit 3Business angels 3Venture capital 3

–––Max marks 12

–––

(b) Limitations of ratio analysisEach limitation 2

–––Max marks 8

–––Total marks 20

–––

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Managing Finances

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

ADVANCED LEVEL

WEDNESDAY 13 DECEMBER 2006

QUESTION PAPER

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examinationhall

The Association of Chartered Certified Accountants

Pape

r T1

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ALL FOUR questions are compulsory and MUST be attempted

1 Morello Landscapes is a small business established several years ago. The owner, Mr Morello, designs and landscapesgardens for a range of clients using his team of five employees. The firm works on one job at a time. Mr Morello hasjust signed a contract with a local building firm to landscape the gardens on a development of thirty executive houses.His designs have already been accepted and he has agreed to complete the work within a six-month period, startingon 1 January 2007. Should he fail to complete the work on time, he will have to pay a penalty. Should the work becompleted early, workers can begin working on the next project.

Mr Morello understands the importance of careful cash budgeting and wants to prepare the cash budget for the nextsix months, from January to June 2007.

The following information has been obtained:

(i) Opening debtors are forecast to be £2,400, all of which will be received in January.

(ii) A price of £400,000 has been agreed for the contract. The amount will be paid in instalments as follows:January 5%February 15%March 10%April 10%May 10%June 50%

(iii) Opening creditors, which will be paid in January, are forecast to be as follows:Materials £6,600Miscellaneous £2,570

(iv) Five diggers will be hired at the start of the job in January to level the land. They will be hired for the wholemonth at a cost of £1,200 each. The fee is payable in full on the first day of hire. A deposit of £500 per diggeris also payable at this point but this amount is refunded in full on the return of the vehicles on the first day ofFebruary.

(v) Various materials are needed to complete the work and these will be purchased at different times over the sixmonths. Ace Ltd supplies all the soil and turf and Hardcastle Ltd supplies the sand, cement and bricks/stones.Shrubs and ‘other materials’ are bought from several different companies. Materials have to be kept on thedriveways of the properties during the landscaping process. Since space is restricted, the following schedule ofpurchases has been drawn up:

Materials Month Purchased Amount Credit termsSoil January £12,600 NoneSand February £2,200 One monthCement February £3,100 One monthBricks/stones March £85,000 Two monthsTurf May £48,000 One monthShrubs May £16,700 NoneOther materials Every month £2,000 per month None

The two key suppliers do charge delivery costs but these are already included in the above amounts. Both keysuppliers also give a 10% bulk order discount on any individual order that exceeds £40,000 in any given month.Mr Morello has not taken any bulk discounts into account when calculating the above figures.

(vi) A waste disposal company has agreed to remove waste throughout the six months at a total cost of £8,500. Thismust be paid in January.

(vii) Each of Mr Morello’s five employees is paid a salary of £21,600 per annum. They are all paid on the last workingday of each month for that month’s work. Mr Morello has also agreed to give each worker a bonus of £1,500 inJune for completion of the contract within the six-month period.

(viii) The firm uses three vans, which the five workers share. These are leased at an annual cost of £3,960 each,payable in equal monthly instalments on the first day of each month.

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(ix) Mr Morello himself uses a business car that has already been fully paid for. He plans to sell the car in April for£3,000 cash, giving rise to an anticipated profit on disposal of £600. His replacement car, to be bought andpaid for in the same month, is expected to cost £18,500. He charges depreciation of £300 each month in hisaccounts for the existing car and will charge £385 per month for the new car. Depreciation is charged in full inthe month of acquisition but not at all in the month of disposal.

(x) Mr Morello’s business account is expected to be overdrawn by £14,200 at the beginning of January.

(xi) The bank charges interest of 1% per month on an overdrawn balance, calculated on the closing bank balanceeach month, and payable the following month. No interest is credited on positive balances.

Required:

(a) Prepare a monthly cash budget for each of the six months to 30 June 2007, showing the cash balance atthe end of each month. Assume that the contract is completed on time. (24 marks)

In the past, Mr Morello has had problems with Hardcastle Ltd delivering the wrong materials or delivering thematerials late. Its prices are so good that he does not want to buy from anybody else. However, it has been such aproblem that he is considering making all of these purchases at the beginning of January. He feels that it would alsobe useful to have a basic understanding of the essential elements of a contract so that he knows his position whendealing with problems with suppliers.

(b) Discuss the costs and benefits, for Mr Morello, of ordering materials early. No additional calculations arerequired. (8 marks)

(c) Briefly outline two essential elements of a contract. Do not discuss ‘form’ since most contracts do not haveto be in any strict legal form. (4 marks)

(d) The local building firm that Morello Landscapes has entered into the new contract with has only been in businessfor five years. Mr Morello therefore had to check on the creditworthiness of the firm.

List four external sources of information that Mr Morello may have used to provide assurance about thecreditworthiness of the local building firm. (4 marks)

(40 marks)

3 [P.T.O.

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2 ‘Nippers’ is a children’s nursery. It is a profitable business and demand for child places always exceeds supply becauseof the great shortage of local nurseries. It is owned and managed by a lady called Mrs Dibble. All the staff at thenursery are either relatives or good friends of Mrs Dibble’s and even the shortest-serving member of staff has workedat the nursery for ten years. Mrs Dibble is planning on retiring on her sixtieth birthday in six years’ time, at whichpoint she hopes to sell the business to one or some of the existing staff. She wants to work full-time until then sinceshe enjoys working so much.

She is currently considering whether to extend the building in order to create more space so that she can meet thedemand for nursery places. Mrs Dibble’s brother has offered to do the extension, by himself, at a very competitiveprice. He is currently unemployed and he faces bankruptcy if he does not find work soon. Mrs Dibble estimates that,with the extension, she would be able to sell the business as a going concern for £600,000 in six years’ time. Withoutthe extension, she would expect to sell it for £500,000 in six years’ time.

A local builder has recently approached Mrs Dibble with an unexpected offer to buy the nursery now for £850,000.He hopes to build apartments on the land.

Mrs Dibble needs to decide whether to carry on in business without the extension (Option 1), have the extension built(Option 2), or sell to the developer (Option 3). The following information is available.

1. Mrs Dibble has already obtained preliminary planning permission for the extension at a cost of £1,200.

2. Mrs Dibble’s building costs are estimated to be £85,000. Of this amount, £45,000 relates to materials and mustbe paid immediately. The balance of the building costs relates to labour and will be paid on completion of thework. The work would take one year to complete. The nursery would still be open as usual during the year sorevenue would be unaffected by the building work.

3. The nursery currently generates net cash inflows of £98,000 per annum. With the extension, these would riseto £135,000 once the work is complete. Mrs Dibble pays herself a salary, but this amount has already beendeducted before arriving at the £98,000.

4. The nursery’s cost of capital is 10% per annum.

5. Assume that all cash flows occur at the end of each year, unless otherwise stated.

Required:

(a) Using the discount tables provided at the end of the question, calculate the net present value (NPV) of eachoption at the business’s cost of capital. Based on these calculations, conclude as to which option Mrs Dibbleshould choose. (16 marks)

(b) Outline four non-financial factors that Mrs Dibble should take into account before finally making a decision.(4 marks)

Discount factor tables at a discount rate of 10%Time Factor1 0·9092 0·8263 0·7514 0·6835 0·6216 0·564

Annuity factor tables at a discount rate of 10%Time Factor1 0·9092 1·7363 2·4874 3·1705 3·7916 4·355

(20 marks)

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3 Noise Ltd makes and sells sound equipment to a range of clients. Its main supplier, Speak Ltd, has never offereddiscounts for early payment so Noise Ltd has always taken the full 60 days’ credit allowed by Speak Ltd.

Speak Ltd has recently been having problems collecting its debts on time. Following this, a decision has been madeto offer customers a 2% discount for all invoices paid within two weeks (14 days) of purchase.

Noise Ltd can invest cash to obtain an annual return of 12%.

Required:

(a) Determine whether it is financially viable for Noise Ltd to take advantage of the early payment discount.(7 marks)

(b) From Speak Ltd’s point of view, what might be three benefits of offering such settlement discounts to itscustomers? (3 marks)

(c) Discuss four features of a credit control system that would encourage customers to pay on time.(10 marks)

(20 marks)

4 Zimmer plc is a listed company specialising in the manufacture and distribution of mobility aids, ranging from walkingsticks to wheelchairs. The company directors are considering branching out into the manufacture and distribution ofstair lifts. Such expansion would require considerable capital investment and the company is therefore consideringhow it could finance the project.

Required:

Explain:

(a) the advantages and disadvantages, to a company, of debt finance over equity finance; (8 marks)

(b) the reasons why a company may choose to issue preference shares rather than ordinary shares or debt;(4 marks)

(c) four factors that will be taken into account by a bank when deciding whether or not to lend money to a client.(8 marks)

(20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2006 Answers

1 Morello Landscapes(a) Cash budget Jan Feb Mar Apr May Jun

£ £ £ £ £ £Cash inflowsOpening debtors 2,400Contract receipts 20,000 60,000 40,000 40,000 40,000 200,000Returned deposits (5 x £500) 2,500Car disposal proceeds 3,000

––––––– ––––––– ––––––– ––––––– ––––––– ––––––––22,400 62,500 40,000 43,000 40,000 200,000––––––– ––––––– ––––––– ––––––– ––––––– ––––––––

Cash outflowsOpening creditors:– Materials 6,600– Miscellaneous 2,570Digger hire (5 x £1,200) 6,000Digger deposit (5 x £500) 2,500Materials:– Soil 12,600– Turf 43,200– Sand 2,200– Cement 3,100– Bricks/stones 76,500– Shrubs 16,700– Other materials 2,000 2,000 2,000 2,000 2,000 2,000Waste disposal 8,500Salaries [(£21,600/12) x 5] 9,000 9,000 9,000 9,000 9,000 9,000Bonus (5 x £1,500) 7,500Van lease payments[(£3,960/12)x3] 990 990 990 990 990 990New car costs 18,500Depreciation – ignore (non-cash)

––––––– ––––––– ––––––– ––––––– ––––––– ––––––––50,760 11,990 17,290 30,490 105,190 62,690––––––– ––––––– ––––––– ––––––– ––––––– ––––––––

Net cash flow (28,360) 50,510 22,710 12,510 (65,190) 137,310Opening balance (14,200) (42,702) 7,381 30,091 42,601 (22,589)Overdraft interest (142) (427) – – – (226)

––––––– ––––––– ––––––– ––––––– ––––––– ––––––––Closing balance (42,702) 7,381 30,091 42,601 (22,589) 114,495

––––––– ––––––– ––––––– ––––––– ––––––– ––––––––

(b) BenefitsMr Morello will reduce his delivery costs since only one delivery from Hardcastle Ltd will be necessary.

He may also reduce his purchase costs by making purchases before any potential price rises come into effect.

He will also benefit from an increased bulk purchase discount, since he will now receive a 10% discount on the sand andcement.

The materials will also be available as and when required. This means that workers will not have to sit idle waiting formaterials to arrive. There will therefore be a greater chance of the contract being completed on time. In turn, this means thatthe penalty will not be payable.

Workers will also be able to start another job earlier should the contract be completed within the six month period. This willbring extra revenue to the business.

CostsIf more materials are left on driveways for longer, there is an increased risk of stock loss either due to pilferage, weather, oraccidents. For example, the sand and cement may get damaged by rain/wind, and the stones/bricks may get cracked.

Since there is restricted storage space on the driveways anyway, some materials may need to be stored elsewhere, for whichthere will be a cost (e.g. local warehouse).

Insurance costs will probably rise if greater quantities of stock are to be held at one time.

There is also the cost of capital being tied up in stock.

Finally, if the customer needs to change his requirements, pre-ordered materials may become surplus, resulting in increasedcosts for Mr Morello unless the contract states that changes the customer will be responsible for such costs.

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(c) ContractsLegal intentionBoth parties to a contract must have intended it to be legally binding. In commercial arrangements such intention is assumed.In domestic or social arrangements such intention may need to be proved.

OfferAn ‘offer’ is a definite promise to be bound on specific terms. It can be made orally or in writing. It can also be implied froma person’s conduct. An offer can be revoked at any time before it is accepted.

Acceptance‘Acceptance’ is the unconditional agreement, by the offeree, to all the terms of the offer. As with an offer, it can also be oral,written or implied from a person’s conduct.

Consideration‘Consideration’ is one party doing something in exchange for another party doing something. Often, there is just an exchangeof promises, or alternatively, consideration may simply be the price.

Note: Only two elements were required.

(d) SourcesBank referencesTrade referencesCredit reference agenciesThe pressCounty Court recordsCompany Registry searchInformal conversations with people connectedInternet

NOTE: Only four sources were required.

2 ‘Nippers’(a) NPV

Option 1: No changeNet present value = (£98,000 x 4·355) + (£500,000 x 0·564) = £708,790

Option 2: Extending the premisesTime

0 1 2–5 6Planning permission(ignore – sunk)Building costs: materials (45,000)Building costs: – labour (40,000)Operating cash inflows 98,000 135,000 135,000Sale price 600,000

–––––––– ––––––– –––––––– ––––––––Net cash flow (45,000) 58,000 135,000 735,000

–––––––– ––––––– –––––––– ––––––––Discount factor/Annuity factor 1 0·909 2·882 0·564

–––––––– ––––––– –––––––– ––––––––Discounted cash flow (45,000) 52,722 389,070 414,540

–––––––– ––––––– –––––––– ––––––––The NPV of option 2 is £811,332

Working 1AF for T2 to T5 = 3·791 – 0·909 = 2·882

Option 3: SellingSince the nursery would be sold immediately, the NPV of this option is simply the sale proceeds of £850,000 (applying adiscount factor of 1 at T0)

Mrs Dibble should sell to the developer (Option 3) since this option produces the highest NPV.

10

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(b) Other factors to take into account– If Mrs Dibble extends the nursery she will provide work for her brother and stop him from possibly going bankrupt.

– The extension will also provide much needed additional child care places for local children.

– The extension will enable Mrs Dibble to carry on working. She may have to look for a new job if she sells up, given thatshe wishes to work until retirement age.

– Mrs Dibble's staff will all lose their jobs if she sells to the developer.

– The shortage of child care in the area will increase further if Mrs Dibble sells to the developer since all the children willlose their places at the nursery.

– However, the building of the extension is likely to cause some noise and disruption at the nursery.

– Mrs Dibble may want the building to remain a nursery, in part as a monument to her good work over the years.

Note: Only four factors were required.

3 Noise Ltd(a) Whether to pay within one week

Effective interest rate over 46 days is:

2= 2·04%––

98

Compound annual interest rate is:[1·0204 365/46 – 1] x 100 = 17·38%.

(Simple annual interest rate is 2·04% x365

= 16·18%.)–––46

Noise Ltd should pay early as the annualised benefit of the discount (17·38%) exceeds the opportunity cost of capital (12%)

[Alternative method of calculation

Cost of not taking the discount:

where d is the size of the discount; t is the reduction in payment period in days which would be necessary to obtain the discount.

(b) Benefits of offering settlement discounts

– Customers are encouraged to pay early, which reduces the costs associated with providing trade credit, such as financingcosts, and also the administrative costs of chasing debts.

– The cash flow position of Speak Ltd will be improved, enabling the company to maintain liquidity.

– Customers may actually buy more from Speak Ltd, as the discount may make their prices appear cheaper than those ofcompetitors.

– There may be fewer bad debts arising since customers are keen to pay early and benefit from discounts.

Note: Only three benefits were required.

(c) Credit control systemsAwareness of supplier’s termsThe customer must be fully aware of the supplier’s terms. As well as the terms being clearly printed in bold on the face ofevery invoice, payment terms should be clearly stated in writing when the order is confirmed.

Even before this time, when the customer account is set up, the contract should state that the customer accepts the supplier’sterms.

Accurate and prompt invoicingInvoices should be correctly drawn up. They will need to include the customer’s name and address, product details and costs,customer’s authorisation reference, purchase order number and supplier’s details. The invoice should be totalled correctly andit should be clear where payment is to be sent to and by what time.

The invoice must be sent out promptly to maximise time for payment.

11

100100 –

–1 100

365

dt

⎝⎜⎜

⎠⎟⎟

×

10098

–1

36546

⎜⎜

⎠⎠

⎟⎟

×100=17·38%]

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Page 106: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Awareness of customer’s systemsIt is important to understand the payment system at your customer’s business. Some businesses make payments to suppliersonly once a month. If this is the case, they will have a cut off point each month by which invoices must be received andprocessed. Some businesses have an informal policy that suppliers are not to be paid until a reminder or even final reminderis received.

Some businesses will only pay out a certain amount each month in order to control their cash flow.

Without this knowledge of client’s systems, debts cannot always be collected promptly.

System of statements and remindersYour customer should be sent a monthly statement showing, as a minimum, the individual invoices outstanding, the age ofthe invoices and the total balance outstanding.

Late payments should always be followed by the issue of a reminder and perhaps a telephone call. Should the debt stillremain unpaid, a final reminder should be issued.

If all else fails and it appears that the customer has no intention of paying, the debt should be passed promptly to a debtcollection agency.

4 Zimmer plc

(a) Advantages of debt finance

– Debt finance is cheaper than equity finance. This is because, firstly, it is less risky for the lender and, secondly, intereston debt is deductible for tax purposes whereas dividend payments are not.

– Issuing debt is relatively cheap compared to issuing equity. This is because there is no need to issue a prospectus etcfor a debt issue.

– The issue of debt does not affect ownership and control of the company because debt holders are not owners of thecompany.

– It is easier to arrange debt finance than equity finance. The company law requirements and the Stock Exchange rules(if it is a listed company) make the issue of equity quite a lengthy procedure.

Disadvantages of debt finance

– As the level of debt increases with each debt issue, the cost of equity will also increase to reflect the increased financialrisk of the company.

– Debt, unlike equity, has to be repaid at the end of its term. This can cause financial difficulty for the company if theyhave insufficient funds. If a company cannot pay its debts it faces the risk of bankruptcy.

– Interest MUST be paid on debt whereas dividend payments on ordinary shares are discretionary. Unlike with dividends,if the company is having a bad year it must still pay its interest charges.

– If the company has borrowed at a floating rate of interest, the company is subject to interest rate risk. This means it riskshaving to pay increased interest charges if the interest rates go up.

– Security for the debt may be required by the lender. This can restrict the company’s use of the assets on which the debtis secured.

– Loan agreements may make the company subject to restrictive covenants. These are effectively promises to keep, e.g.,the current ratio at a certain level.

(b) Reasons for issuing preference shares

– Preference shares do not carry voting rights. This means that they do not give the purchaser any control over thedecisions made by the company. Hence, the issue of preference shares does not dilute control.

– Preference share capital is not secured on the assets of the company like debt. It does not therefore restrict thecompany’s borrowing power or its use of its assets.

– Preference dividends do not have to be paid if the company cannot afford it, although they will often carry the right tocumulative dividends, i.e. if the dividend is not paid one year, it is carried forward to the next year and so on.

– Irredeemable preference shares lower the company’s gearing ratio, which is generally seen as a good thing. However,redeemable preference shares are usually treated as debt for the purpose of calculating the gearing ratio, so they WILLincrease gearing.

12

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(c) Factors considered by a bankThe factors to be considered are set out below.

The character of the borrowerBefore lending money, the bank will need to decide whether the borrower is of good character. This will involve looking at theborrower’s past record and conducting a personal interview with the applicant.

If a person is applying for a loan, they will often be credit scored. If a company is making the application, the bank willprobably use key ratios to analyse the company’s financial position.

The ability to borrow and repayThe bank looks at a business customer’s financial performance in order to ascertain their likely future position.

If the owner re-invests profits in the business rather than drawing them all out, it shows that he has some confidence in thesuccess of the business. This makes the bank more likely to lend to the business.

When dealing with a company that is applying for finance, the bank may check whether the company has the authority toborrow the funds it is requesting. The company’s articles of association provide this information.

The margin of profitsThe bank lends money in order to make money. It needs to ensure that it makes enough of a profit to warrant the risk that ittakes by lending.

Most banks have lending policies which require them to charge different interest rates to customers depending on the reasonfor the borrowing. This is because some types of lending are more risky than others.

Ultimately, it is the bank’s discretion to charge whatever interest rate they choose. For risky ventures, the rate will obviouslybe higher.

Purpose of the borrowingThe purpose of the borrowing affects not only the interest rate but also the bank’s decision as to whether or not to lend in thefirst place.

A bank will not lend money for an illegal purpose. It will normally lend in order to finance working capital, provided that thecompany’s liquidity position is still manageable.

Lending to finance new business ventures is more risky since many of them fail. The bank will be more cautious in thesecases.

Amount of the borrowingFirstly, the bank will need to make sure that the applicant is not asking for more money than he needs for the purposespecified. If he is, this casts doubt over his ability to repay.

Secondly, the bank needs to be sure that the applicant is asking for enough money. If he is not, the bank may well end uphaving to lend more in order to safeguard the original loan.

Repayment termsThe bank must not lend money to a person or company who does not have the ability to repay it, with interest, irrespectiveof any security available for the loan. Security should only be called upon as a last resort if there is a sudden unexpectedinability to pay.

A repayment term should be set which is realistic. Overdrafts are repayable on demand and are therefore more risky for theborrower.

Insurance against the possibility of non-paymentWhen lending large sums of money to an individual or to a company, the bank may well ask for the loan to be secured. Thissecurity may take the form of title deeds to property – either property of the company or the individual’s house, dependingon who is making the application for finance.

A borrower may take out payment protection insurance, so that his repayments are covered even if his financial positiondeteriorates.

Note: Only four factors were required.

13

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Page 108: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2006 Marking Scheme

Marks1 (a) Cash budget

Opening debtors 0·5Contract receipts 2Returned deposits 0·5Van sales proceeds – correct fig. 2Opening creditors:– materials 0·5– miscellaneous 0·5Digger hire 0·5Digger deposit 0·5Materials:– Soil 1– Turf 1– Sand 1– Cement 1– Bricks/stones 1– Shrubs 1– Other materials 1Waste disposal 0·5Salaries 0·5Bonus 0·5Van lease payments 1New van costs 0·5Depreciation – ignore 2Overdraft interest 1Net cash flow 1Opening balance 1Closing balance 1Presentation 1

–––24–––

(b) StockBenefits– delivery costs 1– bulk order discount 1– materials readily available 1– no penalty 1– increased revenue 1– avoid price increases 1

Costs– damage to stock 1– warehouse cost 1– insurance cost 1– capital tied up 1– materials becoming surplus 1

–––Max. marks 8

–––

(c) ContractsEach element 2

–––Max. marks 4

–––

(d) CreditworthinessEvery source 1

–––Max. marks 4

–––Total marks 40

–––

15

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Marks2 (a) NPVs

Option 1Correct relevant cash flows 1Correct DF/AF 1Follow-on NPV 1Option 2Planning permission 1(ignore – sunk)Building costs: materials 1Building costs: – labour 1Operating cash inflows 2Sale price 1Correct DF/AF 1Net cash flow 1Discounted cash flow 1Follow-on NPV 1Option 3Correct NPV 1

Use of annuity factors 1Conclusion 1Presentation 1

–––Max. marks 16

–––

(b) FactorsEach factor 1

–––Max. marks 4

–––Total marks 20

–––

3 (a) Discount calculationEffective discount 3Annualised 3Conclusion 1

–––Marks 7

–––

(b) Benefits of settlement discountsEach benefit 1

–––Max. marks 3

–––

(c) FeaturesSupplier’s terms 3Accurate and prompt invoicing 3Customer’s systems 3Statements and reminders 3

–––Max. marks 10

–––Total marks 20

–––

16

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Page 110: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Marks4 (a) Debt

For each adv./disadv explained 2–––

Max. marks 8–––

(b) Preference sharesEach reason 2

–––Max. marks 4

–––

(c) Bank lendingEach factor explained 2

–––Max. marks 8

–––Total marks 20

–––

17

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Page 111: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Managing Finances

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

ADVANCED LEVEL

WEDNESDAY 13 JUNE 2007

QUESTION PAPER

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examinationhall

The Association of Chartered Certified Accountants

Pape

r T1

0

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Page 112: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

ALL FOUR questions are compulsory and MUST be attempted

1 Go Green Ltd is a small company specialising in the manufacture of a small range of environmentally friendly toiletriesand cleaning products. It is considering extending its production lines to include environmentally friendly soap andwashing-up liquid.

The company’s research and development department has already spent £450,000 developing the products and afurther £325,000 on test marketing them. If the company decides to proceed with the project, new machinery willbe purchased immediately and production will commence straight away.

Notes1. Forecast sales in ‘000 units, are as follows:

Years1 2 3 4 5

Soap 250 200 150 90 30Washing up liquid 240 280 320 170 50

2. Forecasts for the revenues and costs per unit for each of the new products have been made, as detailed below.However, these may need to be revised as per notes (a) to (c) below.

Soap Washing-up liquid£ £

Selling price 1·75 1·60Direct materials (0·15) (0·35)Direct labour (note a) (0·25) (0·12)Variable overheads (note b) (0·50) (0·24)Allocated fixed overheads (note c) (0·65) (0·65)

–––––– ––––––Profit £0·20 £0·24

–––––– –––––––––––– ––––––

(a) The product cost cards for both products above have been prepared on the basis that each factory workeris paid a standard hourly rate of £6. Further details of labour requirements are as follows:

Year oneProduction of each unit of soap requires 2·5 minutes of one factory worker’s time. However, all workers arecurrently working to full capacity. Therefore, for the first year’s production of soap, they will have to workovertime, for which they are paid £7·20 per hour.

Production of each unit of washing-up liquid requires 1·2 minutes of one factory worker’s time. During thefirst year, temporary workers provided by an agency will be used to produce the washing-up liquid at a costto the company of £7 per hour.

Years two to fiveNew permanent staff will be recruited to produce both soap and washing-up liquid. They will be paid at thecompany’s standard hourly rate of £6 per hour.

(b) Variable overheads represent factory power costs, which vary according to labour hours worked.

(c) Allocated fixed overheads comprise factory rental costs of £0·10 per unit and depreciation of £0·55 per unit.

3. The company will need to purchase a new piece of machinery immediately costing £500,000 if the project is toproceed. Some modifications will need to be made to the machinery on site. They will take place as soon as themachinery is purchased and will take two days to complete. The cost of these will be £150,000, payable oncompletion. The machinery will have no scrap value at the end of the project.

4. There are currently two production lines that are not in use on the top floor of the factory. If the project goesahead, these two lines will be used for production. If the project does not go ahead the top floor will be rentedout immediately to a third party, producing income of £125,000 per annum, receivable annually in arrears.

5. Go Green Ltd’s cost of capital is 10% per annum.

6. Assume that all cash flows occur at the end of the year unless otherwise stated.

2

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Page 113: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

7. All workings should be in £’000 to the nearest £’000.

Required:

(a) Using the discount factors provided, calculate the net present value of the proposed project over five yearsand conclude whether the project should be accepted. (20 marks)

(b) Calculate the internal rate of return of the project using the tables provided. (5 marks)

(c) Calculate the discounted payback period for the project at the company’s cost of capital. If the company onlyaccepted projects with a discounted payback period of three years or less, decide whether the companyshould accept this project. (4 marks)

The company has now decided that the project should be funded using debt finance, but it is unsure which form ofdebt finance would be best.

Required:

(d) Discuss three factors that any business should consider when deciding whether a loan or an overdraft is thebest way to finance a project. (6 marks)

(e) Recommend and briefly explain whether an overdraft or a loan would be the most appropriate form of financefor Go Green Ltd. (3 marks)

(f) What is the UK government’s ‘Loan Guarantee Scheme’ and how might it help Go Green Ltd, if required?(2 marks)

Extracts from discount factor tables

Time Factor Factor10% 20%

1 0·909 0·8332 0·826 0·6943 0·751 0·5794 0·683 0·4825 0·621 0·402

(40 marks)

3 [P.T.O.

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2 Camp Ltd is a retailer of real wood flooring. It buys and sells 20,000 packs of flooring each year from its supplier,Strong Ltd.

The real wood flooring from Strong Ltd costs £35 per pack. There is an order processing charge of £150 per order,irrespective of the quantity of packs ordered, and Strong Ltd takes 10 days to deliver the wood flooring. The averagecost of holding one pack of real wood flooring for one year is £9.

A new supplier of real wood flooring, Fake Ltd, has offered Camp Ltd wood flooring on slightly different terms. FakeLtd guarantees that its wood will never arrive damaged since it uses special packaging designed for maximumprotection. It charges £34·95 per pack for the flooring. There is an order processing charge of £160 per order,irrespective of the quantity of packs ordered, and Fake Ltd takes 7 days to deliver the goods. The average cost ofholding one pack of Fake Ltd’s real wood flooring for one year is £12. This is because the special packaging takes upadditional storage space.

The economic order quantity, which will minimise costs, is:

Where Co = the cost of placing one orderD = the annual demand in unitsCh = the cost of holding one unit per annum.

Required:

(a) Under the current arrangement, calculate:

(i) the economic order quantity for packs of wood flooring;(ii) the total cost (ordering, purchase and holding cost) of stocking wood flooring for one year. (5 marks)

(b) For the new supplier calculate:

(i) the economic order quantity for packs of wood flooring;(ii) the total cost (ordering, purchase and holding cost) of stocking wood flooring for one year (5 marks)

Camp Ltd has decided that it is NOT going to change suppliers. It, therefore, contacts Fake Ltd and informs them thatit does not wish to change suppliers. Fake Ltd has now offered Camp Ltd a bulk purchase discount of 1% on all singleorders for 2,000 or more packs of wood.

Required:

(c) Calculate and conclude whether it is worth accepting the offer by ordering 2,000 packs at a time from FakeLtd. (4 marks)

(d) Outline three non-financial factors that should be taken into account when deciding whether to changesuppliers from Strong Ltd to Fake Ltd. (6 marks)

(20 marks)

4

EOQ CoDCh

= 2

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Page 115: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

3 Porkys Ltd is an ice cream manufacturing company preparing its accounts to 31 May each year. The company’s peakseason occurs in the months of July, August and September and it always prepares a profit forecast for this period.

The following cash budget has been prepared for the six months ending 30 November 2007.

Jun Jul Aug Sep Oct Nov£’000 £’000 £’000 £’000 £’000 £’000

Receipts from sales 1,100 1,250 1,400 1,800 2,200 1,700Sale of machinery – 45 – – – –

–––––– –––––– –––––– –––––– –––––– ––––––Total receipts 1,100 1,295 1,400 1,800 2,200 1,700

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––

PaymentsIngredients 250 280 360 440 340 340Labour 350 450 550 425 275 250Sundry expenses 75 85 95 80 70 65Purchase of machinery – – 120 – 60 –Loan repayments 50 – 50 – 50 –

–––––– –––––– –––––– –––––– –––––– ––––––Total payments 725 815 1,175 945 795 655

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––

Receipts less payments 375 480 225 855 1,405 1,045Opening cash balance b/f 1,400 1,775 2,255 2,480 3,385 4,790Interest received – – – 50 – –

–––––– –––––– –––––– –––––– –––––– ––––––Closing cash balance c/f 1,775 2,255 2,480 3,385 4,790 5,835

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––

Notes/assumptions made when preparing the cash flow forecast1 Customers always take two month’s credit.2 The machinery to be sold for £45,000 will give rise to a profit on disposal of £3,000.3 Depreciation of £13,000 will accrue during the three months ending 30 September 2007.4 One month’s credit is always taken from suppliers of ingredients.5 There are no stocks of raw materials or finished goods maintained.6 Labour is paid by BACS on the last day of each month, for that month’s work.7 Sundry expenses are all paid in the month in which they are incurred.8 The loan repayment relates to an interest free loan obtained from Porkys Ltd’s parent company.9 Interest is received by Porkys Ltd from the bank twice a year. The interest receivable for the peak season of July,

August and September is expected to be £30,000. 10 All workings should be in £’000s to the nearest £’000.

Required:

(a) Prepare a profit forecast for the three months ending 30 September 2007. Show all workings clearly. Whereany items have been excluded from the profit forecast, include a note to justify your treatment of the item.

(10 marks)

Porkys Ltd’s parent company is considering centralising the treasury function for the whole group.

(b) List four roles of a treasury department. (4 marks)

(c) Describe three advantages of having a centralised treasury department. (6 marks)

(20 marks)

5 [P.T.O.

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Page 116: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

4 Jay Ltd manufactures furniture. It has come under pressure in recent years to reduce prices in order to compete withsome larger competitors in the market. The company’s aim has therefore been to maintain sales levels, with the effectthat debtor control has been allowed to deteriorate. The company has always had a target of keeping the debtorsperiod at an average of 45 days.

Debtors as at 31 May 2007 are £323,654. Sales for the year ending 31 May 2007 were £1,581,743. This figureincluded £14,250 of cash sales. During this time, debts of £26,784 were written off. All £26,784 relates to salesmade in the year ending 31 May 2007.

Required:

(a) Calculate the current debtors collection period, in days, from the above information. (3 marks)

(b) How much of the year-end debtors’ balance would have to be immediately recovered in order to reduce thedebt collection period to the target level? (2 marks)

(c) Calculate the company’s bad debt ratio for the year ended 31 May 2007. (2 marks)

(d) List five procedures that could be used to pursue the overdue debts. (5 marks)

Jay Ltd has carried out some of the procedures to collect debts. One of its major debtors is still refusing to pay on thebasis that it was not satisfied with the quality of some of the goods it received and had to make refunds to its owncustomers. Jay Ltd does not want to sue the customer but has heard of ‘arbitration’.

(e) Explain what arbitration is, in this context. (2 marks)

(f) State two advantages and two disadvantages of using arbitration as opposed to taking a case to court.(4 marks)

You have now learnt that arbitration will not be possible since your client informs you that it is actually insolvent. Youhave heard that creditors can attempt to recover monies owing to them through ‘liquidation’.

(g) Briefly explain what happens when a company goes into liquidation. (2 marks)

(20 marks)

End of Question Paper

6

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Page 117: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Answers

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Page 118: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

ACCA Certified Accounting Technician Examination – Paper T10Managing Finance June 2007 Answers

1 Go Green Ltd

(a) NPV of the project 0 1 2 3 4 5£’000 £’000 £’000 £’000 £’000 £’000

Product development costs – sunkTest marketing costs – sunkNet cash inflow – soap (w.1) 200 170 128 77 26Net cash inflow – iquid (w.1) 209 249 285 151 45Fixed overheads (irrelevant)New machinery (500)Modifications (150)Lost top floor income (125) (125) (125) (125) (125)

–––––– –––––– –––––– –––––– –––––– ––––––Net cash flow (650) 284 294 288 103 (54)

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––Discount factors at 10% 1·000 0·909 0·826 0·751 0·683 0·621

–––––– –––––– –––––– –––––– –––––– ––––––Present value (650) 258 243 216 70 (34)

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––

The net present value of the project is approximately £103,000. Since it is positive, the project should be accepted.

Working 1: Net cash inflow per unit

Soap Year 1 Year 2–5£ £

Sales price 1·75 1·75Direct materials –0·15 –0·15Direct labour (£7·20 ÷ 60 x 2·5 for year 1) –0·30 –0·25Variable overheads –0·50 –0·50

––––– –––––Net cash inflow per unit 0·8 0·85

––––– –––––––––– –––––

Washing up liquid £ £Sales price 1·60 1·60Direct materials –0·35 –0·35Direct labour (£7 ÷ 60 x 1·2 for year 1) –0·14 –0·12Variable overheads –0·24 –0·24

––––– –––––Net cash inflow per unit 0·87 0·89

––––– –––––––––– –––––

Working 2: Total net cash inflow per year

Soap 1 2 3 4 5Sales in units (’000) 250 200 150 90 30Net cash inflow per W.1 0·80 0·85 0·85 0·85 0·85

£’000 £’000 £’000 £’000 £’000Total net cash inflow 200 170 128 77 26

––––– ––––– ––––– ––––– –––––––––– ––––– ––––– ––––– –––––

Washing up liquidSales in units (’000) 240 280 320 170 50Net cash inflow per W.1 0·87 0·89 0·89 0·89 0·89

£’000 £’000 £’000 £’000 £’000Total net cash inflow 209 249 285 151 45

––––– ––––– ––––– ––––– –––––––––– ––––– ––––– ––––– –––––

9

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Page 119: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Alternatively, the answer may have been presented as follows, although it would have been more time effective to adopt theformer approach.

Year0 1 2 3 4 5

£’000 £’000 £’000 £’000 £’000 £’000Product development costs (sunk)Test marketing costs (sunk)Sales: soap 438 350 263 158 53– washing up liquid 384 448 512 272 80Direct materials: soap (38) (30) (23) (14) (5)– washing up liquid (84) (98) (112) (60) (18)Direct labour: soap (w.1) (75) (50) (38) (23) (8)– washing up liquid (w.1) (34) (34) (38) (20) (6)Variable overheads: soap (125) (100) (75) (45) (15)– washing up liquid (58) (67) (77) (41) (12)Fixed overheads (irrelevant)New machinery (500)Modifications (150)Lost top floor income (125) (125) (125) (125) (125)

–––––– –––––– –––––– –––––– –––––– ––––––Net cash flow (650) 283 294 287 102 (56)

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––Discount factors at 10% 1·000 0·909 0·826 0·751 0·683 0·621

–––––– –––––– –––––– –––––– –––––– ––––––Present value (650) 257 243 216 70 (35)

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––

The net present value of the project is approximately £101,000. The difference in NPV compared to the former method usedarises because of rounding differences.

Working 1: Direct labourSoap: cost per unit in year 1 = £7·20 ÷ 60 x 2·5 = £0·30

1 2 3 4 5Sales in units 250 200 150 90 30Cost per unit 0·3 0·25 0·25 0·25 0·25

£’000 £’000 £’000 £’000 £’000Annual cost 75 50 37·5 22·5 7·5

––––– ––––– ––––– ––––– ––––––––– ––––– ––––– ––––– ––––

Liquid: cost per unit in year 1 = £7 ÷ 60 x 1·2 = £0·141 2 3 4 5

Sales in units 240 280 320 170 50Cost per unit 0·14 0·12 0·12 0·12 0·12

£’000 £’000 £’000 £’000 £’000Annual cost 33·6 33·6 38·4 20·4 6

––––– ––––– ––––– ––––– ––––––––– ––––– ––––– ––––– ––––

(b) IRR of the project Time0 1 2 3 4 5£ £ £ £

Net cash flow (650) 284 294 288 103 (54)Discount factors at 20% 1·000 0·833 0·694 0·579 0·482 0·402

–––––– –––––– –––––– –––––– –––––– ––––––Present value (650) 237 204 167 50 (22)

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––

The net present value of the project at a discount rate of 20% is approximately £(14,000).

Where A is the lower rate and B is the higher rate; a is the NPV at the lower rate and b is theNPV at the higher rate.

= 18·655%

= 18·803%

10

IRR A aa b

B A

IRR

≈ + × ⎡⎣

⎤⎦

⎛⎝⎜

⎞⎠⎟

≈ + ×

––

–10 103117

20 10⎡⎡⎣

⎤⎦

⎛⎝⎜

⎞⎠⎟

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Page 120: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

(c) Discounted payback period

Time Annual discounted cash flows Cumulative discounted cash flows£’000 £’000

0 (650) (650)1 258 (392)2 243 (149)3 216 674 70 1375 (34) 104

The discounted payback period for the project is between two and three years. This means that the project will have recoveredits capital outlay at this point.

Since the company accepts projects with a discounted payback period of three years or less, the company should accept theproject.

(d) Factors to consider Purpose of the borrowingIf the cash is required to fund temporary shortfalls in cash, it is easier and more appropriate to obtain an overdraft. This isbecause an overdraft is more flexible and can be increased or decreased (within its limit) on a day-to-day basis. The mainpurpose of an overdraft is to fund day-to-day shortfalls in cash rather than long-term projects.

A loan, on the other hand, is more suitable for a fixed asset investment, the benefits of which will accrue over a number ofyears.

Duration of the borrowingThis links in closely with the purpose of the borrowing. If the cash is needed for a long time, a loan should be sought.Conversely, if the cash is only needed for a short time, an overdraft is more appropriate since this can be paid back just assoon as the business can afford it. This means that the business only has to pay interest for as long as the borrowing is reallyrequired, rather than interest being payable for the whole term of the loan.

Interest ratesThe interest rates payable on an overdraft are often higher than the interest rates payable on a loan. This is because anoverdraft is such a flexible arrangement and that flexibility comes at a cost. A business will want to minimise the interest thatit pays out.

SecurityThis factor needs to be considered from two angles. Firstly, the bank will probably require security for a medium-term loan.If the business has no security to offer then it may not be able to obtain the loan. An overdraft is more easily obtained withoutsecurity. This is because the bank can keep a close eye on the business’s cash flows and immediately demand repayment ofthe overdraft if it has any cause for concern.

Secondly, the business may want to be secure in the knowledge that knows exactly how much its repayments will be andwhen they will be due cash for a number of years. It has this security with a loan, whereas, with an overdraft, the bank candemand repayment at any time.

Note: Only three factors were required.

(e) Finance for Go Green Ltd

The main reason why Go Green Ltd needs cash is to purchase the machinery costing £500,000. This is a fixed asset forwhich the benefits will accrue over a long period of time. This would initially indicate that a medium-term loan would be moreappropriate.

A loan may be preferred by the bank since the new machinery may provide adequate security for the loan, although thisdepends on the potential resale value of the machinery.

A loan would probably be preferred by Go Green Ltd because, firstly, the interest costs are likely to be lower and, secondly,the bank cannot suddenly demand repayment of the money in full. This is reassuring, especially since the sales levels do notrise really high until the third year of the project.

(f) Loan Guarantee Scheme

This scheme is available to small companies with turnover of £5.6 million per annum or less. Through this scheme, thegovernment facilitates lending to small businesses by providing security for up to 75% of the value of the loan, for loans of amaximum amount of £250,000.

Therefore, Go Green Ltd could apply for this assistance if it meets the criteria, in order to obtain a loan to assist with the costsof the machinery. This might be necessary if other security is not available i.e. if, for example, the machinery is not suitablefor use as security for the loan. This may be the case if the machinery’s resale value has been affected by the modificationsmade to it.

11

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2 Camp Ltd

(a) Current supplier

(i) EOQ

Where the Co = the cost of placing one orderD = the annual demand in unitsCh = the cost of holding one unit per annum.

(ii) Total cost:

Holding cost: average stock x unit holding cost= (816 ÷ 2) x £9 = £3,672.

Ordering cost = number of orders x £150Number of orders = annual demand ÷ EOQ

= 20,000 ÷ 816= 24·5

Therefore ordering cost = £3,675 per annum.

Purchase cost = 20,000 x £35= £700,000.

Total cost for one year = £3,672 + £3,675 + £700,000= £707,347

––––––––––––––––––

(b) New supplier

(i) EOQ

(ii) Total cost:

Holding cost: average stock x unit holding cost= (730 ÷ 2) x £12 = £4,380.

Ordering cost = number of orders x £160Number of orders = annual demand ÷ EOQ

= 20,000 ÷ 730= 27·4

Therefore ordering cost = £4,384 per annum.

Purchase cost = 20,000 x £34·95= £699,000.

Total cost for one year = £4,380 + £4,384 + £699,000= £707,764

––––––––––––––––––

(c) DiscountHolding cost = (2,000 ÷ 2) x £12 = £12,000.

Ordering cost = (20,000 ÷ 2,000) x £160= £1,600.

Purchase cost = £699,000 x 99%= £692,010.

Total cost for one year = £12,000 + £1,600 + £692,010 = £705,610.

––––––––––––––––––

The discount means that it is worth changing suppliers.

12

EOQ CoDCh

= 2

EOQ = × ×

=

2 150 20 0009

816

,

EOQ = × ×

=

2 160 20 00012

730

,

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(d) Non-financial factors

– Quality of Fake Ltd’s wood. This may not be as good as Strong Ltd’s wood, although it should be as there is very littledifference in price. The new wood should be closely inspected to ensure that it is of the same thickness as the currentwood.

– Reliability of Fake Ltd. Fake Ltd appears to have a shorter lead time for orders (seven days instead of 10 days) but ifthey are not able to send stock consistently on time, Camp Ltd may end up running out of stock. This could mean thatcustomers go elsewhere, leading to lost revenue for the company.

– Packaging of Fake Ltd’s wood. Fake Ltd’s packaging needs to look attractive, otherwise customers will not buy it. Inaddition, it needs to protect the wood well, as the guarantee claims.

– Range. There are many different types of wood, e.g. beech, maple and oak. Camp Ltd need to ensure that all thecurrently stocked types of wood are on offer from the new supplier.

– Returns policy. Fake Ltd appear to offer a guaratee that the wood will arrive undamaged but Camp Ltd may still need tomake returns. Fake Ltd’s policy would need to be understood and the extent to which they are contactable to deal withproblems would be relevant.

Note: Only three factors were required.

3 Porkys Ltd

(a) Profit forecast for the three months ending 30 September 2007

£’000Sales (1) 5,700Purchases (2) (1,140)Labour (1,425)Depreciation (13)Profit on disposal (3) 3Interest receivable 30Sundry expenses (260)

––––––Net Profit 2,895

––––––––––––

Workings

1. Sales = receipts from Sept, Oct and Nov. since the cash is received two months in arrears.£1,800,000 + £2,200,000 + £1,700,000 = £5,700,000.

2. Purchases – paid one month in arrears so use CFF figures from Aug, Sep, Oct.Ingredients: £’000(£360,000 + £440,000 + £340,000) 1,140

––––––

3. Profit on disposal – it is this revenue figure that is relevant for the profit and loss forecast, rather than the actual saleproceeds of £45,000 since this is a capital disposal.

Notes for items excluded from the profit forecast

1. Purchase of machinery – these are capital payments and are only relevant in so far as they are used to calculatedepreciation.

2. Loan repayments – ignored since these are capital in nature, not revenue.

(b) Roles of a treasury department

– banking– cash management– funding management– foreign currency management– corporate finance– risk management – insurance

Note: Only four were required.

(c) Advantages of a centralised treasury department

– higher interest rates may be attainable on investments because the department has larger amounts of cash available forinvestment.

– experts can be employed with specialised knowledge, more qualified to make manage risk and make better investmentdecisions.

13

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– foreign currency management becomes easier, since the foreign currency expenditure in one company can be matchedwith receipts in the same currency in another group company.

– lower interest rates may be sought for borrowing, since borrowing can be arranged for the group as a whole.

– the level of cash held for precautionary purposes can be minimised since only one amount will be required for the wholegroup.

– the treasury department may be a profit centre in its own right, resulting in an increased likelihood of a profit beingmade.

Note: Only three advantages were required.

4 (a) Current debtors collection period

Credit sales = £1,581,743 – £14,250 = £1,567,493

Debtor days= debtors/credit sales x 365= (£323,654 ÷ £1,567,493) x 365= 75 days.

(b) Debtors needs to be reduced to:

£1,567,493 x 45/365 = £193,253

Debts to be collected immediately = £323,654 – £193,253 = £130,401.

(c) Bad debt ratio

Bad debt ratio = bad debts/credit sales x 100%= £26,784 ÷ £1,567,493 x 100%= 1.7%

(d) Procedures for collecting debts

– Telephone customers and request that they pay their debts as soon as possible, informing them if they have exceededtheir credit period.

– Write to customers, enclosing a copy of their most recent statement showing all their outstanding invoices.

– Arrange a personal visit to customers’ premises so that you can discuss the need for payment and any reasons for non-payment.

– Freeze customers’ accounts so that they are forced to pay before they can order more goods.

– Send customers formal warnings or final demands, stating that if their debts are not paid, further action will be taken,and stating what that further action is.

– Refer the debts to a debt collection agency who will pursue debts on the company’s behalf.

– Arrange for your solicitor to send your overdue customers a letter stating that if payment is not received within a certainperiod, legal proceedings will be commenced.

– Commence legal proceedings i.e. issue a summons or a writ (depending on the amount of the debt).

Note: Only five were required.

(e) Arbitration is the process whereby a debtor and a creditor enter into a written agreement to submit their dispute to a thirdparty who assists in its resolution. The parties produce all relevant documents to the arbitrator and are then examined underoath. The decision of the arbitrator is final.

(f) Advantages

– less costly than court action– more flexible

Disadvantages– arbitrator’s powers not as extensive as a judge’s powers in court.– arbitrator’s decision not as objective, since case not examined in same level of detail, or according to the rules of

evidence in court.

(g) Liquidation

The company is dissolved as a legal entity. Its assets are then sold to raise cash, which is used to pay creditors. Any moneyleft over (usually none!) is then given to the shareholders.

14

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Page 124: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2007 Marking Scheme

Marks1 (a) NPV (Alternative method)

Ignoring development costs 1 Ignoring development costs 1Ignoring test marketing costs 1 Ignoring test marketing costs 1Net cash inflow – soap: sales fig. 1 Sales: soap 1Direct materials 1 – washing up liquid 1Direct labour 2 Direct materials: soap 1Variable overheads 1 – washing up liquid 1Net cash inflow – WUL: sales fig. 1 Direct labour: soap 2Direct materials 1 – washing up liquid 2Direct labour 2 Variable overheads: soap 1Variable overheads 1 – washing up liquid 1Fixed overheads – ignore 1 Fixed overheads – ignore 1New machinery cost 1 New machinery cost 1Modifications cost 1 Modifications cost 1Lost top floor income 1 Lost top floor income 1Net cash flow 1 Net cash flow 1Present value 1 Present value 1NPV 1 NPV 1Conclusion 1 Conclusion 1

––– –––20 20

––– –––

(b) IRRNPV calculation at 20% 2Correct IRR formula 1Correct IRR calculation 2

–––5

–––

(c) Discounted paybackAnnual cash flows 1Cumulative cash flows 1Discounted payback calculation 1Conclusion 1

–––4

–––

(d) FactorsFor each factor discussed 2

–––Total 6

–––

(e) RecommendationRecommendation 1Reasons 2

–––3

–––

(f) Loan guarantee schemeWhat it is 1How it might help. 1

–––2

–––Total marks 40

––––––

15

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Marks2 (a) Old supplier

EOQ 2Total costs 3

–––5

–––

(b) New supplierEOQ 2Total costs 3

–––5

–––

(c) DiscountTotal costs 3Conclusion 1

–––4

–––

(d) FactorsEach factor 2

–––Max. 6

–––Total marks 20

––––––

3 (a) Profit and loss forecastSales (right figure) 1Purchases 1Labour 1Depreciation 1Profit on disposal: correct figure 1Interest receivable 1Sundries 1Forecast profit – correct figure 1Note on mach. purchase 1Note on loan repayments 1

–––10

–––

(b) Roles of treasury departmentEach role 1

–––Max. 4

–––

(c) AdvantagesEach advantage 2

–––Max. 6

–––Total marks 20

––––––

16

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Marks4 (a) Debtors collection period

Credit sales figure 1Ratio calculation 2

–––3

–––

(b) Debts collectedNew debtors figure 1Collect debtors figure 1

–––2

–––

(c) Bad debts ratioRatio calculation 2

–––2

–––

(d) Debt collectionEach method 1

–––Max. 5

–––

(e) ArbitrationWritten agreement 1Under oath 1Binding 1

–––Max. 2

–––

(f) Advantages/disadvantagesEach one 1

–––Max. 4

–––

(g) LiquidationDissolved 1Assets sold 1Cash paid to creditors/SHs 1

–––Max. marks 2

–––Total marks 20

––––––

17

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Page 127: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Certified Accounting Technician ExaminationAdvanced Level

Time allowedReading and planning: 15 minutesWriting: 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor.

During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet untilinstructed by the supervisor.

This question paper must not be removed from the examination hall.

Pape

r T1

0

Managing Finances

Wednesday 12 December 2007

The Association of Chartered Certified Accountants

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Page 128: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

ALL FOUR questions are compulsory and MUST be attempted

1 Robo Clean Co is a recently established innovation company. It currently has one product on the market, the‘Robovac’, a robotic floor cleaner. This has been extremely successful. The company is currently developing a newrobotic cleaner called ‘Robomum’ that vacuums, dusts and presses.

To date $120,000 has been spent on developing the product. The company has also incurred $250,000 of marketresearch costs, although the invoice for these costs has only just been received and will be paid in January.

Since the set-up costs are substantial, a final decision now needs to be made as to whether it is viable to manufactureand sell ‘Robomum’. The following revenues and costs have been estimated:

1. A new factory, to be used solely for the production of ‘Robomum’, will need to be built. This will take nearly ayear to build and is expected to cost $11·75 million in total, payable in two instalments. The first instalment of$6m will be paid at the start of the building work and the second instalment for the remaining balance will bepaid when the building work has been completed at the end of the year.

2. Robo Clean Co will immediately enter into a one-year contract with a project management company, who willoversee the building of the factory. The total cost of this during the year will be $250,000.

Two production lines will need to be installed in the factory at a further cost of $1,500,000 payable at the endof the build in one year’s time.

3. The machinery for the production of ‘Robomum’ also needs to be built-to-order and is expected to cost $2·5m,payable in one year’s time. Its terminal value is nil. Depreciation will be charged as soon as productioncommences (as soon as the build finishes in one year’s time) at 10% per annum on a straight-line basis.Maintenance costs for the machinery are estimated at $250,000 per annum.

4. Production and Sales will commence in the year following the build. Sales quantities and prices for ‘Robomum’are expected to be as follows:

Years 1 2 3 & 4 5 to 9(each year) (each year)

Sales volume (’000 units) 5 10 30 50Sales price ($) 1,000 800 700 500

It is anticipated that by the beginning of year 10, a new robotic helper will have replaced ‘Robomum’, hencethere will be no further sales.

5. Material costs for ‘Robomum’ are estimated at $125 per unit.

6. Labour costs are estimated at $100 per unit.

7. Fixed production overheads on the new factory are estimated at $240,000 per annum. Variable productionoverheads are expected to be $50 per unit.

8. Head office costs of $4·5m per annum will be allocated to ‘Robomum’ when production commences. Of thesecosts, only $3·7m is incremental.

9. The introduction of ‘Robomum’ is expected to adversely affect sales of ‘Robovac’. It is thought that, for every twounits of ‘Robomum’ sold, one unit of ‘Robovac’ will be lost. ‘Robovac’ is currently sold for $150 per unit andgenerates a net cash flow of $50 per unit.

10. The company’s cost of capital is 5%.

11. Assume that all cash flows occur at the end of the year, unless stated otherwise.

12. All workings should be in $’000, to the nearest $’000.

2

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Required:

(a) Using the discount tables provided, calculate the net present value (NPV) of the project at the company’scost of capital. Conclude as to whether Robo Clean Co should proceed with the project. (22 marks)

(b) Explain the main principles to differentiate between relevant and irrelevant costs for investment appraisal.Wherever possible, use the costs of ‘Robomum’ to illustrate your answer. (6 marks)

(c) Define and distinguish between capital and revenue expenditure. Explain whether the $250,000 per annumcosts of maintaining the machinery for ‘Robomum’ are capital or revenue in nature. (6 marks)

(d) Robo Clean Co is considering alternative ways of funding the project. The machinery is one of the largest costs.The company has heard of hire purchase agreements, finance leases and operating leases, but is not surewhether any of these will be suitable, given that the machinery has to be built-to-order.

Briefly describe each of the following

(i) Hire purchase agreements; (2 marks)

(ii) Finance leases; (2 marks)

(iii) Operating leases. (2 marks)

Present value table (extract)

Periods (n) Discount rate (r)5%

1 0·9522 0·9073 0·8644 0·8235 0·7846 0·7467 0·7118 0·6779 0·64510 0·614

Annuity factor table (extract)

Periods (n) Discount rate (r)5%

1 0·9522 1·8593 2·7234 3·5465 4·3296 5·0767 5·7868 6·4639 7·10810 7·722

(40 marks)

3 [P.T.O.

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2 All Weather Windows Co manufactures and fits windows for domestic customers. The company needs to forecast itsworking capital requirements for the year ahead. The following figures are available:

Sales revenue $7,600,000

Costs as percentage of sales revenueRaw materials 22%Direct labour 18%Variable production overheads 7%Apportioned fixed production overheads 12%Other costs 5%

Working capital statisticsAverage raw material holding period 6 weeksAverage work-in-progress (WIP) holding period 3 weeksAverage finished goods holding period 5 weeksAverage trade receivables’ collection period 2.5 weeksAverage trade payables’ payment period on:Raw materials 8 weeksDirect labour 2 weeksVariable production overheads 4 weeksFixed production overheads 6 weeksOther costs 3 weeks

Other relevant information1. All finished goods inventory and WIP values include raw materials, direct labour, variable production overheads

and apportioned fixed production overhead costs.

2. Assume WIP is 80% complete as to materials; 75% complete as to direct labour; 50% complete as to variableproduction overheads and fixed production overheads.

3. Assume there are 52 weeks in one year.

4. Assume that production and sales volumes are the same.

5. All workings should be in $’000, to the nearest $’000.

Required:

(a) Calculate the estimated average working capital required by All Weather Windows Co for the year, showingall necessary workings. (14 marks)

4

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Page 131: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

(b) All Weather Windows Co approaches its bank to ask for a loan to assist with a new machinery purchase. Thebank refuses the loan on the basis that the company is too highly geared and its interest cover is too low. Theindustry averages for gearing and interest cover are as follows:

Industry average

GearingPrior-charge capital

x 100% 100%–––––––––––––––––Shareholders’ funds

Interest cover 3 times

The following figures are extracts from All Weather Windows Co’s accounts:

Long-term loans $6millionOrdinary share capital $3 millionReserves $1 millionProfit before interest $1.2millionInterest $500,000

(i) Calculate the company’s level of gearing (also known as leverage) using the same ratio as above, andexplain what it means when All Weather Windows Co is said to be ‘highly geared’. (3 marks)

(ii) Calculate the company’s interest cover and explain what it means when All Weather Windows Co is saidto have low interest cover. (3 marks)

(20 marks)

5 [P.T.O.

( )

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3 Cool Ski Co is a skiwear retailer operating through its website shop. It is run by its three directors/shareholders whostarted the business three years ago. Its busiest months of the year are December, January, February and March, withsales for the rest of the year being relatively insignificant.

In December the company prepares a cash budget for January, February and March. The following figures from itsprofit forecast for December 2007 through to March 2008 are currently available. However, they may need to berevised and should be read together with the notes below.

Dec Jan Feb Mar$’000 $’000 $’000 $000

Sales revenue (1) 450 650 750 350Purchases See notes 2 and 3Staff costs (4) 45 60 70 30Packaging costs (5) 7 10 12 6Distribution costs (6) 35 50 58 28Other costs (7) 50 75 85 55

Notes:1. The company does not provide any credit to customers. However, customers who join the company’s members’

club are given a 5% discount on all of their purchases. Half of customers are club members. The sales revenueforecasts above have been calculated before any discounts have been taken into account.

2. Purchases represent 40% of gross sales revenue. Sales revenue in November was $95,000. 3. Suppliers allow two months’ credit.4 All staff are paid at the beginning of the month for the previous month’s work.5. Packaging costs are paid one month after they are incurred.6. Distribution costs are paid in the month in which they are incurred.7. Other costs include depreciation of $12,000 per month. They also include rental costs of $30,000 per month,

which are paid quarterly in December, March, June and September. The remainder of ‘other costs’ are paid inthe month in which they are incurred.

8. The bank charges interest of 0·5% per month for the overdraft, calculated on the closing bank balance eachmonth, and payable in the following month.

9. The overdraft on Cool Ski Co’s bank account at 31 December 2007 is expected to be $500,000.10. All workings should be in $’000, to the nearest $’000.

Required:

(a) Prepare a monthly cash budget for each of the three months to 31 March 2008, showing the cash balanceat the end of each month. (10 marks)

(b) Cool Ski Co is considering expanding its business. It wants to branch out into the manufacture of its own brandof skiwear, and then expand its customer base to include wholesale customers, such as high street retailers. Thethree directors/shareholders have produced a business plan and are now considering approaching a venturecapital organisation for finance.

Identify and discuss five factors that a venture capital organisation would take into account when decidingwhether or not to invest in Cool Ski Co. (10 marks)

(20 marks)

6

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Page 133: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

4 Waste Co is a waste management company, with one sole shareholder/director, Mr Trusty. It collects two types of wastefrom businesses – recyclable waste and confidential waste. Since companies have increasingly become aware of boththe need for recycling and the need to protect confidential information, Waste Co’s client base has expanded rapidlyover the last two years.

As the business has expanded Mr Trusty has had less time available to focus on credit control. This has resulted in asteady deterioration in accounts receivable collection and a rapid increase in Mr Trusty’s overdraft, despite high profits.Mr Trusty’s bank has now refused to extend his overdraft any further and has suggested that he either employ a creditcontroller or factor his accounts receivable.

The following information is available:

1. Credit sales for the year ending 30 November 2007 were $2,550,000 and average accounts receivable dayswere 60. Sales are expected to increase by 25% over the next year.

2. If Mr Trusty employs a good credit controller, the cost to the business will be $47,000. It is anticipated that theaccounts receivable days can then be reduced to 40 days.

3. A local factoring organisation has offered to factor the company’s accounts receivable on the following terms:(i) An advance of 80% of the value sales invoices (which Mr Trusty would fully utilise).(ii) An estimated reduction in accounts receivable days to 35 days.(iii) An annual administration fee of 1·3% of turnover.(iv) Interest charge on advances of 12% per annum.

4. Current overdraft rates are 10% per annum.5. Assume there are 365 days in a year.

Required:

(a) Explain the meaning of ‘debt factoring’ (accounts receivable factoring) to Mr Trusty, distinguishing between‘with recourse’ and ‘without recourse’ agreements. (4 marks)

(b) Explain how debt factoring is different from ‘invoice discounting’. (2 marks)

(c) Calculate whether it is financially beneficial for Waste Co to factor its accounts receivables for the next year,as compared to employing a credit controller. (10 marks)

(d) State four roles that a credit controller may play. (4 marks)

(20 marks)

End of Question Paper

7

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Page 134: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Answers

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Page 135: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2007 Answers

1 (a) NPVTime

0 1 2 3 4 5 6–10$’000 $’000 $’000 $’000 $’000 $’000 $’000

Market research costs (sunk)Development costs (sunk) –Factory costs (6,000) (5,750)Project management company (250)Machinery costs (2,500)Depreciation (non-cash) – – – – – –Maintenance (250) (250) (250) (250) (250)Production lines (1,500)Sales revenue 5,000 8,000 21,000 21,000 25,000Material costs (625) (1,250) (3,750) (3,750) (6,250)Labour (500) (1,000) (3,000) (3,000) (5,000)Fixed overheads (relevant as incremental) (240) (240) (240) (240) (240)Variable overheads (250) (500) (1,500) (1,500) (2,500)Head office costs (incremental element only) (3,700) (3,700) (3,700) (3,700) (3,700)Reduced Robovac contribution (125) (250) (750) (750) (1,250)

–––––– ––––––– –––––– –––––– –––––– –––––– –––––––Net cash flows (6,000) (10,000) (690) 810 7,810 7,810 5,810

–––––– ––––––– –––––– –––––– –––––– –––––– –––––––Discount factor 1 0·952 0·907 0·864 0·823 0·784 3·393Discounted cash flows (6,000) (9,520) (626) 700 6,428 6,123 19,713

The net present value of the project is $16·818 m. The company should therefore proceed with it.

WorkingsAF for T6 – 10 = 7·722 – 4·329 = 3·393

(b) Relevant costs

The following principles should be applied when identifying costs that are relevant to a project.

Relevant costs are future costsA relevant cost is a future cost arising as a direct consequence of a decision. A cost which has been incurred in the past istherefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’. Examples of suchpast costs are the development costs and the market research costs.

Relevant costs are cash flowsOnly those future costs which are in the form of cash should be included. This is because relevant costing works on theassumption that profits earn cash.

Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making. An example ofsuch costs for the Robomum is the depreciation on the new machinery.

Relevant costs are incremental costsA relevant cost is the increase in costs which results from making a particular decision. For example, an opportunity cost (thevalue of a benefit foregone as a result of choosing a particular course of action) will always be a relevant cost. This is becauseit is a future incremental cost. An example of such an opportunity cost for the Robomum is the lost contribution fromdecreased sales of Robovac.

Allocated fixed overheads are not normally incremental. In the case of the Robomum, however, the allocated fixed overheadsrelate to a factory that is being built entirely for the production of Robomum. The costs are therefore relevant because theyare incremental.

As regards the allocated head office overheads, only the incremental part of these overheads is relevant i.e. the $3·7m. Theremainder of the $4·5m is irrelevant to the NPV calculation since it would have been incurred, irrespective of the emergenceof Robomum onto the market.

Certain other costs will also be excluded in the NPV calculation, such as ‘finance costs’. This is because interest has alreadybeen taken into account in the discounting process.

(c) Capital and revenue expenditure

Capital expenditure is expenditure on the purchase of or improvement to fixed assets. Fixed assets are used in the businessto generate income over a number of years. The expenditure on them is therefore charged to the profit and loss account overa number of years through a depreciation charge.

Revenue expenditure, on the other hand, is expenditure incurred in relation to sales, for example, materials and labour costs,or overhead costs. It also includes the cost of maintaining, but not improving, fixed assets.

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The maintenance costs of $250,000 per annum for the machinery are therefore revenue costs. This is because they do notenhance the value of the machinery but merely keep it running properly so that production can continue.

(d) (i) Hire purchaseHire purchase is simply a form of financing an asset through paying in instalments. The supplier of the goods sells themdirectly to the financier (usually a finance house). The supplier then supplies the customer with the goods.

The customer will usually be required to pay a sizeable deposit towards the purchase price of the goods.

The goods remain the property of the financier until the end of the agreement, at which point the customer will havepaid for the goods in full.

The customer makes regular payments throughout the course of the agreement that consist of partly capital repaymentand partly interest.

(ii) Finance leasesA finance lease is similar in substance to a hire purchase agreement. The goods are sold to the lessor. The supplier ofthe goods then supplies the customer with the goods.

In return, the customer makes regular payments to the lessor. Over the period of the lease, the lessee will have paid forthe full costs of the goods plus an additional amount equivalent to an interest charge.

Throughout the lease the lessee is responsible for maintaining the asset.

A finance lease usually has a primary period over which these significant payments are made. At the end of this primaryperiod, the lessee then enters a secondary period. During this time, he will pay a notional charge (perhaps as low as$1 per annum) but continue to have full use of the asset. Alternatively, he may sell the asset on behalf of the lessor,usually keeping most of the sale proceeds himself.

(iii) Operating leasesThis type of lease is very different from a hire purchase agreement or finance lease. The equipment is supplied directlyto the lessee by the lessor. The lessee will make regular payments under the lease.

The lessor will be responsible for maintaining the asset so the lessee avoids the risks of ownership.

The period of the lease is often much shorter than the full life of the asset.

Since the machinery for Robo Clean is built-to-order, an operating lease would not be appropriate.

2 All Weather Windows

(a) Working capital requirements$’000

Sales revenue for the year: 7,600––––––

Raw materials costs$7,600,000 x 22% 1,672Direct labour costs$7,600,000 x 18% 1,368Variable production overheads$7,600,000 x 7% 532Fixed production overheads$7,600,000 x 12% 912Other costs$7,600,000 x 5% 380

––––––4,864––––––––––––

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Current assets:Inventory $’000 $’000Raw materials 6/52 x $1·672m 193W-I-PMaterials 3/52 x $1·672m x 80% 77Direct labour 3/52 x $1·368m x 75% 59Variable and fixed production overheads 3/52 x ($532k + 912k) x 50% 42

––––178

Finished GoodsMaterials and direct labour 5/52 x ($1·672m + $1·368m) 292Variable and fixed production overheads 5/52 x ($532k + $912k) 139

––––431

––––––Total inventory value 802Trade receivables 2·5/52 x $7,600,000 365

––––––Total value of current assets 1,167

––––––

Current liabilitiesAccounts payable:Materials 8/52 x $1·672m (257)Labour 2/52 x $1·368m (53)Variable production overheads 4/52 x $532k (41)Fixed production overheads 6/52 x $912k (105)Other costs 3/52 x $380k (22)

––––––Total value of current liabilities (478)

––––––––––––

Working capital required 689––––––––––––

(b) (i) GearingIt is calculated as follows:

Prior-charge capitalx 100%–––––––––––––––––

Shareholders’ funds

=$6m

x 100%–––––––––––$3m + $1m

= 150%

All Weather Windows’ gearing is 150% as compared to an industry average of 100%. The company is therefore said tobe ‘highly geared’ because its borrowings are simply too high compared to its level of equity.

(ii) Interest coverIt is calculated as follows:

Profit before interest––––––––––––––––

Interest= $1,200,000

–––––––––––$500,000

= 2·4 times

All Weather Windows’ interest cover is only 2·4 times, meaning that its interest payments are only covered by its profits2·4 times.The industry average for interest cover is 3 times. Therefore, compared to the industry that the companyoperates in, its interest cover is deemed to be low, meaning that the profitability of the company is too low given its levelof interest.

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3 Cool Ski Ltd

(a) Jan Feb Mar$’000 $’000 $’000

Cash inflowsSales revenue: non-members 325 375 175Sales revenue: members (5% discount) 309 356 166

–––– –––– ––––Cash inflows 634 731 341

–––– –––– ––––Cash outflowsPurchases (w.1) 38 180 260Staff costs 45 60 70Packaging costs 7 10 12Distribution costs 50 58 28Other costs excl. rent (w.2) 33 43 13Rent (3 x $30k ) 90

–––– –––– ––––Cash outflows 173 351 473

–––– –––– ––––Net cash flows 461 380 (132)Opening balance (500) (42) 338Overdraft interest (3) – –

–––– –––– ––––Closing balance (42) 338 206

–––– –––– ––––

Workings1. Purchases Nov Dec Jan

$’000 $’000 $’000Gross sales revenue 95 450 650

–––– –––– ––––Purchases at 40% 38 180 260

–––– –––– ––––

2. Other costs Each monthJan Feb Mar

$’000 $’000 $’000Per question 75 85 55Less depreciation (12) (12) (12)Less rental costs (30) (30) (30)

–––– –––– ––––33 43 13

–––– –––– ––––

(b) Venture capitalists

Factors that a venture capitalist organisation will take into account are as follows:

(i) Level of expertise of Cool Ski Co’s managementVenture capitalists will believe that the success of Cool Ski Co’s business is dependant on the quality of the management.They will expect the three directors/shareholders to show a high level of commitment to the business. As all of theexisting owners of the business are all involved in the running of the company, this should be proof of their commitment.The venture capitalists will also look at the amount of money that the owners themselves have invested in the projectin assessing their level of commitment. The venture capitalists will expect a place on Cool Ski Co’s Board of Directorsso that they can have a say in future business strategy.

(ii) Level of expertise in the area of serviceThe venture capitalists will seek assurance that the directors have the necessary know-how and technical support to beable to run the business properly. The fact that the business has been supplying the public direct through its website forthe last three years is evidence of the ability of the directors/shareholders to run the company. However, running amanufacturing business is going to be different from simply being a retailer, and dealing with wholesale customers isdifferent from dealing with the public direct. The directors have a lot to prove.

(iii) The nature of Cool Ski Co’s productIn order to succeed in manufacturing and selling their own brand of skiwear, the directors need to show that they haveexcellent designs for a range of skiwear that people will want to buy and wear. The business already has a customerbase with members buying skiwear at reduced prices. This should help the directors in persuading the venture capitaliststhat they have a likeable brand.

(iv) The market and competitionThey will seek assurance that there is actually a market for the ski wear, as there are already some similar membershipsavailable in the market place. They will ask to see the market research that has already been carried out. The venturecapitalists will also look at the threat posed by new entrants in the market, and current rival membership schemes.

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(v) Future prospectsSince the risk involved in investing in a new or expanding company is fairly high, the venture capitalists will seek toensure that the prospects for future profits compensate for the risk. They will therefore want to see the business plansetting out the future business strategy.

(vi) Exit routesThe venture capitalists will consider potential exit routes before they invest in the venture. They will not invest money ina share of the business unless they are confident that it can be sold at some point in the future.

Note: Only five factors were required.

4 (a) Debt factoring‘Debt factoring’ is a service provided by factors whereby the factor collects accounts receivable on behalf of their client andoften invoices their client’s customers as well. The factor also advances, to its client, a proportion of the money it is due tocollect (typically about 80% is advanced.)

Mr Trusty would find the service useful because he could both receive cash early and also delegate the administration of hisinvoicing, accounting and accounts receivable collection work.

There are two types of factoring agreements: ‘with recourse’ and ‘without recourse’ agreements. With the first of theseagreements, although the factor advances monies, the risk of non-payment of accounts receivable balances stays with theclient. If a balance is not recovered, the factor has ‘recourse’ to their client for the money. If the agreement is ‘without recourse’the factor bears the risk of non-payment.

Debt factoring has to be paid for, usually as a percentage of the amounts advanced and as a percentage of turnover.Agreements without recourse to the client obviously cost more. Mr Trusty would have to compare the cost to those ofemploying an individual to do his invoicing and obtaining insurance against unpaid accounts receivable balances. In addition,there may be some stigma attached to debt factoring as clients sometimes assume that a business using a factor must be infinancial difficulty.

(b) Difference from invoice discountingInvoice discounting is a service whereby a provider (often a factoring company) purchases invoices from a client at a discount.In this case, they are merely advancing cash, rather than providing an accounts receivable collection service. For this reason,there is no administration fee payable (like there is for factoring), making invoice discounting a cheaper option.

(c) Whether to factor accounts receivablesCost of factoringNew sales level = $2,550,000 x 125% $3,187,500Accounts receivable reduced to 35 days:$3,187,500 x 35/365 $305,651

$80% advanced by factor at 12%:$305,651 x 80% x 12% 29,34220% still financed by overdraft:$305,651 x 20% x 10% 6,113Admin fee: $3,187,500 x 1·3% 41,438

–––––––76,893––––––––––––––

Cost of not factoring but employing new staffAccounts receivable reduced to 40 days:$3,187,500 x 40/365 $349,315

$Overdraft cost$349,315 x 10% 34,932Credit controller costs 47,000

–––––––81,932––––––––––––––

Waste Co should use the services of the factor since this will produce a saving, over the next year, of $5,039, compared toemploying a credit controller.

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(d) Roles of a credit controllerMay include some/all of the following:

– Updating the sales ledger– Dealing with customers’ queries– Assessing creditworthiness of new customers– Establishing/updating payment terms for customers– Regular review of the sales ledger– Pursuing overdue accounts receivable balances– Providing references for customers

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2007 Marking Scheme

Marks1 (a) NPV

Market research costs ignored 1Development costs ignored 1Project management company 1Factory costs 1Machinery costs 1Depreciation ignored 1Maintenance 1Production lines 1Sales revenue 1Material costs 1Labour 1Fixed overheads 2Variable overheads 1Head office costs (incremental element) 2Reduced Robovac profits 2Net cash flows 0·5Discount factors/annuity factors 1Discounted cash flows 0·5NPV 1Conclusion 1

–––Total marks 22

–––

(b) Relevant costsFuture costs 1Ignore sunk 1Cash flows 1Depreciation 1Incremental 1Opportunity costs 1Lost contribution from Robovac 1Fixed overheads 1Head office 1Finance costs 1

–––Max marks 6

–––

(c) Capital/revenue costsCapital costs 2Revenue costs 2Maintenance costs 2

–––6

–––

(d) HP agreements and leasingHP agreements 2Finance leases 2Operating leases 2Correct mention of Robo Clean 1

–––Max marks 6

–––Total marks 40

––––––

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Marks2 (a) Working capital requirements

Calculation of each cost for year 0·5–––

Max marks 2·5–––

Calculation of current assets:Raw materials 1WIP 3Finished goods 2Debtors 1

–––7

–––

Calculation of current liabilitiesAccounts payable:Creditor 0·5Labour 0·5Variable overheads 0·5Fixed overheads 0·5Other costs 0·5

–––2·5–––

Working capital required 1

Presentation 1–––14

–––

(b) (i) GearingRatio calculation 1Explanation 2

–––3

–––

(ii) Interest coverRatio calculation 1Explanation 2

–––3

–––Total marks 20

––––––

3 (a) Cash budgetSales 2Purchases 2Staff costs 0·5Packaging costs 0·5Distribution costs 0·5Other costs (excl. rent) 1Rent 1Net cash flows 0·5Balance b/f 0·5Overdraft interest 1Balance c/f 0·5

–––10

–––

(b) Venture capitalPer factor 2

–––Max marks 10

–––Total marks 20

––––––

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Marks4 (a) Factoring

Definition 1Includes administration 1With recourse agreements 1Without recourse agreements 1Other points 1

–––Max marks 4

–––

(b) Invoice discountingAdvancing cash only 1No a/cs rec’ble collection service 1Cheaper 1

–––Max marks 2

–––

(c) Cost of factoringNew sales level 1New accounts receivable 112% factoring charge 110% overdraft charge 11·3% admin fee 1

Cost of not factoringNew a/cs rec’ble figure 1Overdraft cost 1Credit controller cost 1Logical approach 1

Conclusion/saving 1–––10

–––

(d) Roles of credit controllerEach role 1

–––Max marks 4

–––Total marks 20

––––––

Total marks for paper 100––––––––

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Certified Accounting Technician ExaminationAdvanced Level

Time allowedReading and planning: 15 minutesWriting: 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Extract from discount factor tables and annuity factor tables are onpage 2.

Do NOT open this paper until instructed by the supervisor.

During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet untilinstructed by the supervisor.

This question paper must not be removed from the examination hall.

Pape

r T1

0

Managing Finances

Wednesday 11 June 2008

The Association of Chartered Certified Accountants

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Extract from discount factor tables at a discount rate of 10%

Time Factor1 0·9092 0·8263 0·7514 0·6835 0·6216 0·5647 0·5138 0·4679 0·42410 0·386

Extracts from annuity factor tables at a discount rate of 10%

Time Factor1 0·9092 1·7363 2·4874 3·1705 3·7916 4·3557 4·8688 5·3359 5·75910 6·145

2

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ALL FOUR questions are compulsory and MUST be attempted

1 Alan Web is a famous musician and composer. He has recently teamed up with a successful producer of musicals,David Daniels. Together, they are going to fund a new musical ‘The Fiesta’. The musical will run in Jamin (the capitalof Bundai) for five months. If it is successful, it will then tour the rest of Bundai for a further period.

Alan and David are each investing $100,000 in the production. They have opened a business bank account to beused solely for the musical’s income and expenses. The investment cash will be paid into this account on 30 June2008. Rehearsals will take place throughout the month of July, with the musical’s official opening night taking placeon 1 August.

Alan and David appreciate the need for cash forecasting and have made the following estimates for income andexpenses for the six months from 1 July to 31 December 2008:

1 Tickets for the musical will go on sale on 1 July. Tickets will be sold through an agent who is to be paidcommission by Alan and David. The price of tickets will vary according to the seat location. Prices are as follows:

Location of seat PriceStalls $30Front $20Rear $15

Ticket sales each month will include not only tickets for that month’s performances but also advance bookingsfor later months. Sales per month are expected to be as follows:

Jul Aug Sep Oct Nov DecStalls 10,000 20,000 No further stalls seats availableFront 30,000 50,000 20,000 No further front seats availableRear 10,000 30,000 40,000 50,000 45,000 35,000

The agent will pay the proceeds of ticket sales into Alan and David’s business account in the same month as thetickets are sold to the public. The agent will then invoice Alan and David for the commission it charges of 6%.This will be payable in the month following the ticket sales.

2 Sales from programmes, CDs and beverages are expected to be $150,000 in August and $175,000 for eachmonth thereafter. All costs relating to the production of these goods will be incurred in July. Costs represent 10%of sales value.

3 All of the staff in notes 4 and 5 below will only receive 50% of their usual monthly salary for the month ofrehearsals.

4 The leading lady, who plays the key role in the musical, will be paid a salary of $16,000 per month. Theremaining 20 cast members (actors/singers) will be paid a monthly salary of $8,000 each. The leading lady andthe cast members will be paid at the end of each month for that month’s work.

5 A live orchestra will also be playing every night. The orchestra also starts rehearsing at the beginning of July.There are 25 musicians in the orchestra, each of whom will be paid a salary of $4,000 per month. Musicianswill be paid at the beginning of each month for the previous month’s work.

6 Other production staff members are provided by an independent production company and are expected to cost$80,000 per month in total. They will not be required until the musical opens in August. They will be paid atthe beginning of each month for that month’s work. However, in addition to this monthly cost, there will also bea production company administration fee of 5%, payable monthly in arrears.

7 The production company charges a separate amount for the production equipment, also required at the beginningof August. This is expected to be $33,000 per month, payable on the first day of each month.

8 The costumes for the cast will be made in July. A deposit of $50,000 needs to be paid at the beginning of July,with the remaining balance of $25,000 to be paid at the end of that month.

9 The background for the stage is currently being painted by local artists. Its cost of $180,000 will be payableupon its completion at the beginning of July.

3 [P.T.O.

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10 The musical will be held at the National theatre, which must be hired for $600,000 per month, payable at thebeginning of each month. The theatre will be used for rehearsals in July as well.

11 Certain equipment, not supplied by the production company, costing $155,000 will be bought in July for theproduction. Depreciation for the six-month period will total $31,000.

12 All workings should be in $’000 to the nearest $’000.

Required:

(a) Prepare a monthly cash budget for the musical for each of the six months to 31 December 2008, showingthe cash balance at the end of each month. (18 marks)

(b) Alan and David are very aware that their actual cash flow in the six months ending 31 December 2008 coulddiffer greatly if the above estimates prove to be inaccurate. They have heard of ‘sensitivity analysis’ and want toknow more about it.

Required:

Briefly explain sensitivity analysis and discuss how it might best be used to make the cash budget for themusical more useful.

Note: no further calculations are required. (6 marks)

(c) Alan and David are considering whether they should set up their own company for future theatrical productions.They want to know whether, over a ten-year period, it would save money.

If they set up the company, they would avoid the following annual costs:

(i) Estimated external production staff costs of $900,000.(ii) Estimated administration fees of $45,000.(iii) Estimated production equipment costs of $400,000.

However, they would incur the following set-up costs immediately:

(i) Legal costs of $4,000.(ii) Company registration costs of $1,000.(iii) Equipment costs of $1,800,000.

A further amount of $1·5 million would be payable for the equipment in one year’s time.

The following annual costs would arise:

(i) Staff salaries of $500,000.(ii) Professional fees of $10,000.(iii) Equipment maintenance costs of $75,000.(iv) Depreciation costs of $200,000.

Alan and David will need to spend a considerable amount of time setting up the company. They estimate that,as a result of this, their revenue may be $75,000 lower in the first year than it would otherwise have been (ignoreagent’s commission). Their cost of capital is 10% per annum.

Required:

Using the discount tables provided, calculate the net present value (NPV) of the proposal to set up theproduction company, at the company’s cost of capital. Advise Alan and David whether they should set upthe company.

Note: show all workings in $’000. (10 marks)

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(d) Alan and David have been advised that the ‘pay-back period method’ may also be a useful way of assessingwhether to set up the production company. They know nothing about this method of project appraisal.

Required:

(i) Explain the simple payback period method;

Note: calculations are not required. (2 marks)

(ii) State two differences between the calculation of the simple payback period of a project as compared tothe calculation of the net present value of a project; (2 marks)

(iii) State two advantages of using the simple payback period method as compared to other methods ofproject appraisal. (2 marks)

(40 marks)

2 Light Co is a privately owned company specialising in the manufacture of lighting equipment. It supplies lighting tocustomers, who take an average of 30 days to pay. It has an overdraft on its current account of $2m. The compoundannual interest rate charged on this account is 12%, with interest being charged to the account daily.

In order to reduce its overdraft, Light Co is now considering introducing discounts to customers who pay within seven days.

Required:

(a) Calculate the maximum discount that Light Co should offer for payment within seven days if it wants to avoidany increase in its overall finance costs and explain the basis of your calculation. (4 marks)

(b) Briefly explain the difference between simple and compound interest rates, using Light Co’s overdraft interestas an example. (4 marks)

(c) One year later, despite introducing a tempting discount to customers, Light Co has found that very few customershave paid early and taken the discount. In fact, receivables days have increased significantly, as has thecompany’s overdraft. Light Co is therefore considering factoring its debts in the coming year.

Credit sales for the last year totalled $12 million, with average receivables of $2 million. Next year, sales areexpected to increase by 10%. Receivables days are expected to increase to 70 days if the factoring arrangementis NOT entered into. A factoring company has put forward the following proposal to Light Co:

(i) Receivables days will be reduced to 28 days as a result of stricter credit control procedures.(ii) The factor will charge interest of 13% per annum on the advances.(iii) The factor will charge an administration fee of 1·5% of turnover for the service.(iv) The factor will advance 80% of the value of sales invoices.

Should Light Co enter into the agreement, it will make its credit controller redundant. She earns a salary of$18,000 per annum. Current bank overdraft rates have remained the same at 12% per annum.

Required:

Evaluate whether it is financially viable for Light Co to factor its debts in the coming year. (12 marks)

(20 marks)

5 [P.T.O.

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3 The Kitchen Co is an innovation company set up two years ago by its key shareholder and director, Brian Geek. Itcurrently has a range of about two thousand kitchen products on the market, the most successful of which is a gadgetcalled the ‘Fish Eye’. This is a revolutionary utensil, the size of a kitchen knife, which plugs into the power supplyand is used on cooked fish to identify any fish bones that need to be removed prior to serving. The ‘Fish Eye’ explodedonto the market two years ago, as the company’s introductory product, and sales have continued to grow rapidly eversince.

One of Brian Geek’s friends has warned him about the high incidence of overtrading for new businesses selling highdemand, innovative products. Brian Geek is therefore concerned that The Kitchen Co’s financial position be carefullymonitored. Its turnover has increased by 100% over the last year, and its trade receivables and inventories havedoubled. The company’s current ratio has fallen over the last year from a ratio of 3:1 to a ratio of 2·5:1. The industrynorm is 2:1.

The company has a $1 million overdraft facility on its current account from its bank. Whilst the company has neverused even half of its limit, it often relies on the overdraft facility to finance its working capital.

Required:

(a) Explain the term ‘overtrading’. (2 marks)

(b) Describe the symptoms that MAY be present in a company that is overtrading. (5 marks)

(c) Briefly discuss whether The Kitchen Co is overtrading. (5 marks)

(d) One of the key components used to make the ‘Fish Eye’ is component X, which is imported from overseas. BrianGeek wants to manage his inventory levels of component X more efficiently. He wants to make sure that he canmeet demand for production and sales whilst at the same time avoiding excessive inventory levels. The followinginformation relates to component X:

Cost of component X $24 per unitUsage per day 1,000 unitsMaximum lead time 20 daysMinimum lead time 10 daysAverage lead time 15 daysCost of ordering $650 per orderHolding costs $2 per unit per annum

Usage per day is always constant. The re-order level is set at the maximum expected requirement in lead timeplus 25%.

Required:

(i) Calculate the re-order level; (3 marks)

(ii) Calculate the Economic Order Quantity (EOQ) using the following formula:

Where Co = the cost of placing one orderD = the annual demand in unitsCH = the cost of holding one unit per annum

Note: you should assume that there are 48 working weeks in the year and five working days in each ofthe weeks. (2 marks)

(iii) Calculate the maximum inventory level for component X using the information provided. (3 marks)

(20 marks)

6

EOQC D

Co

H

=2

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4 Banks and the money markets play an important role in a country’s economy.

Required:

(a) Explain the difference between retail banks and wholesale banks. (4 marks)

(b) Describe four functions of a central bank. (8 marks)

(c) Name the different money markets and briefly explain their role within the economy. (4 marks)

(d) Briefly describe four money market instruments. (4 marks)

(20 marks)

End of Question Paper

7

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Answers

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11

ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2008 Answers

1 (a) Cash budget

Jul Aug Sep Oct Nov Dec$’000 $’000 $’000 $’000 $’000 $’000

ReceiptsTicket sales (1) 1,050 2,050 1,000 750 675 525Other sales (2) 150 175 175 175 175

–––––– –––––– –––––– –––––– –––––– ––––––1,050 2,200 1,175 925 850 700

–––––– –––––– –––––– –––––– –––––– ––––––PaymentsCosts re ‘other sales’ 85Leading lady’s salary 8 16 16 16 16 16Other cast members 80 160 160 160 160 160Musicians 50 100 100 100 100Production company staff 80 80 80 80 80Production company fee 4 4 4 4Production equipment 33 33 33 33 33Costumes 75Stage background 180Theatre hire 600 600 600 600 600 600Equipment costs 155Depreciation – ignoreTicket agent’s commission (2) 63 123 60 45 41

–––––– –––––– –––––– –––––– –––––– ––––––Total payments 1,183 1,002 1,116 1,053 1,038 1,034

–––––– –––––– –––––– –––––– –––––– ––––––

Net cash flow (133) 1,198 59 (128) (188) (334)Opening balance b/f 200 67 1,265 1,324 1,196 1,008

–––––– –––––– –––––– –––––– –––––– ––––––Closing balance c/f 67 1,265 1,324 1,196 1,008 674

–––––– –––––– –––––– –––––– –––––– –––––––––––– –––––– –––––– –––––– –––––– ––––––

Workings

(1) Ticket salesStalls $’000 $’000 $’000 $’000 $’000 $’000Front 300 600Rear 600 1,000 400Total 150 450 600 750 675 525

–––––– –––––– –––––– –––––– –––––– ––––––1,050 2,050 1,000 750 675 525

–––––– –––––– –––––– –––––– –––––– ––––––(2) Ticket agent’s commission

–––––– –––––– –––––– –––––– –––––– ––––––6% of sales, one month later 0 63 123 60 45 41

–––––– –––––– –––––– –––––– –––––– ––––––

(b) Sensitivity analysisIn order to prepare a cash budget, many assumptions have to be made. In the case of ‘The Fiesta’ the biggest assumptionbeing made is in relation to ticket sales. Whilst former experience of ticket sales for this type of musical can be used as abasis for the sales estimates, the fact is that it is an unknown variable. This is also the case for ‘other sales’. Certain items inthe cash budget can be calculated with more certainty, for example, theatre hire costs, staff costs and production equipmentcosts. This is because these costs are largely fixed, that is, they will not vary according to ticket sales. Sensitivity analysis isless useful on these items unless there is uncertainty about their actual cost.

Sensitivity analysis uses models in order to determine the changes on our cash budget if some of the key variables change.Given that ticket and other sales are the least predictable, sensitivity analysis would be most useful on these items. Forexample, the cash budget could be reperformed on the assumption that ticket sales and other sales were 10%, 20% and30% less than estimated. A computerised model could be used to make the calculations easier and the sensitivity analysismore complicated.

Using sensitivity analysis in this way would make it easier to ascertain the level of risk attached to the project.

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(c) Net present value T0 T1 T2–10$’000 $’000 $’000

Saved production costs 900 900Saved admin fees 45 45Saved equipment costs 400 400Legal costs (4)Registration costs (1)Equipment (1,800) (1,500)Maintenance costs (75) (75)Lost revenue (75)Salaries (500) (500)Professional fees (10) (10)Depreciation – ignore

–––––– –––––– ––––––Net cash flow (1,805) (815) 760

–––––– –––––– ––––––Discount factor/annuity factor* 1·000 0·909 5·236

–––––– –––––– ––––––Discounted cash flow (1,805) (741) 3,979

–––––– –––––– ––––––

* Annuity factor for T2–T10 = 6·145 – 0·909= 5·236

The net present value of setting up the production company, as opposed to carrying on as normal, is $1·433 million. Alanand David should, therefore, set it up.

(d) Payback method

(i) The payback period method assesses the feasibility of a project by ascertaining the length of time it takes for theinvestment costs of a project to be paid back by the revenues/cost savings. It is therefore the length of time it takes forthe total cash inflows to equal the original cash outflows.

(ii) It is different from the NPV method because firstly, it looks at simple cash flows and not discounted cash flows, thusignoring the time value of money.

Secondly, whilst the NPV method takes into account all the cash flows over the life of the project, the payback methoddisregards any cash flows arising after the original investment has been paid back.

(iii) – It is easy to calculate and easy to understand.– It uses cash flows rather than profits, therefore it is less likely to be distorted by accounting conventions.– It helps liquidity by taking into account the timescale rather than the overall cash flows.

2 (a) Maximum discount

Effective interest rate over 23 (30 – 7) days is:

(1·1223/365 – 1) x 100 = 0·717%

The maximum discount that Light Co should offer, if it does not want to increase its finance costs, is 0·717%.

Explanation

If customers are to be given a discount for paying within seven days, Light Co is effectively paying to receive the cash 23 (30– 7) days early.

Therefore, in order to calculate the maximum discount that should be offered to customers for paying within seven days, it isnecessary to calculate the effective interest rate that Light Co is paying on its overdraft for the 23 day period. This figure shouldthen be the maximum amount that Light Co should offer its customers for early payment.

(b) Interest rates

Light Co has a compound annual interest rate of 12%, with interest being charged to its account daily. This 12% rate thereforetakes into account that, on an annual basis, interest is not only being charged on any capital amounts but also on any interestthat is debited to the current account each day. Therefore, it is called compound interest because interest is being paid oncapital AND interest over the course of the year.

A ‘simple’ interest rate, on the other hand, only takes into account the interest payable on any capital amounts. So, in LightCo’s case, it ignores any interest payable that is incurred on the interest that is credited to Light Co’s account each day.(Note: This could be demonstrated using numbers.)

12

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(c) Whether to factor

Existing finance cost at 12% $New sales figure ($12m x 1·1) 13,200,000Receivables ($13,200,000 x 70/365) 2,531,507Overdraft cost per annum at 12% 303,781

––––––––––––––––––––––Cost of factoringSales 13,200,000Receivables reduced to 28 days:$13,200,000 x 28/365 1,012,603

–––––––––––80% advanced by factor at 13%:$1,012,603 x 80% x 13% 105,31120% still financed by overdraft:$1,012,603 x 20% x 12% 24,302Admin. Fee:$13,200,000 x 1·5% 198,000Saved salary (18,000)

–––––––––––309,613

––––––––––––––––––––––Additional cost of factoring (5,832)

––––––––––––––––––––––ConclusionIt is not financially viable for Light Co to factor its debts as an additional cost of $5,832 will arise.

3 (a) Overtrading

A company is said to be overtrading when its sales are expanding too quickly for it to finance them. Further explained, thismeans that the volume of sales is too large given the level of long-term capital at the company’s disposal.

(b) Symptoms of overtrading– A rapid increase in turnover– A rapid increase in the volume of current assets and sometimes fixed assets– A significant reduction in liquidity ratios– An increase in debt ratios– A rapid increase in trade payables– A rapid increase in bank overdraft

(c) The Kitchen Co’s turnover has increased by 100% over the last year. However, since this is a new company and the ‘FishEye’ is an innovative product for which this company is the sole retailer, one would expect to see a large increase in turnover.

Similarly, since sales have increased so much, trade receivables would have been expected to increase proportionately, whichthey did. Since a 100% increase in turnover is effectively a doubling in turnover, the doubling of trade receivables was to beexpected.

Again, inventory levels have doubled. This is also linked to the doubling of turnover. Inventory levels would have beenincreased in order to meet the increase in demand.

The company is relying heavily on its overdraft but it is not exceeding it; nor is it uncommon for a new business to rely onthis form of short-term finance to fund its working capital.

Whilst the current ratio has deteriorated it is still 2·5:1, which is higher than the industry norm.

In conclusion then, whilst the company’s financial position needs to be monitored carefully to ensure that sales do not spiralout of control, the company does not currently appear to be overtrading.

(d) (i) Re-order level

Re-order level = max. lead time x usage x 125%= 20 x 1,000 x 125%= 25,000 units.

(ii) Economic order quantity

= 12,490 units.

13

EOQC D

Co

H

=

=

2

2 x 650 x 48 x 5 x 1,0002

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(iii) Maximum inventory level

Calculated as follows:

Re-order level + re-order quantity – (minimum rate of usage x minimum lead time)

= 25,000 + 12,490 – (1000 x 10)

= 27,490.

4 (a) Retail and wholesale banks

Retail banks are those banks that specialise in the provision of banking facilities to the public and businesses. The amountsof the deposits and loans that they deal with tend to be relatively small. In the UK, traditional high street banks such asBarclays and LloydsTSB are retail banks. Much of their business is now done over the telephone and internet.

Wholesale banks, on the other hand, are banks dealing in larger deposits and loans. They are not in the business of providinghousehold mortgages and small loans to businesses and consumers. They tend to have a small number of large customersand deal extensively in the foreign exchange market. They include merchant banks such as Kleinwort Benson and Hambros,and finance houses.

(b) Functions of a central bank

Banker to the banksIt provides a payments system for transactions between banks.

Banker to the government The central bank collects tax revenue and disburses government expenditure.

Issuance of currencyThe central bank prints/mints and issues notes and coins for the government, usually backed by holdings of governmentbonds.

Monetary policy functionThe Central Bank executes monetary policy on behalf of the government. This facilitates the control of inflation, which isdamaging to the economy.

Reserve managementThe central bank manages the portfolio of foreign exchange reserves of the country and may buy or sell them to influence theexchange rate.

Maintain financial stabilityThe central bank does this through the supervision of other banks.

Lender of the last resortA central bank may be called upon to act as lender of the last resort to the banking system.

(Government debt managementIn several countries, central banks issue long term government debt in the market. This is no longer the common practice inmost countries today, however.)

(Note: Only 4 functions were required)

(c) Money markets

These are markets which trade money for short-term borrowing and lending, in wholesale amounts. They enable financialinstitutions to cover short-term money shortages or to lend money profitably if they have surplus money. Trading is done eitherover the telephone or electronically.

Money markets include a ‘primary market’ and a ‘secondary market’. The primary market is used by the central bank andother approved banks and securities firms. The central bank uses it to smooth out shortages and surpluses of cash.

The ‘secondary market’ includes:– the interbank market– the eurocurrency market– the certificates of deposit market– the intercompany market– the local authority market.

(d) Money market instruments

– Deposits: deposits of money with financial intermediaries such as banks.

– Bills: short-term financial assets which can be converted into cash at short notice by selling them in the discount market.

– Commercial paper: short-term IOUs issued by large companies. They can either be held until maturity or sold on beforethen.

– Certificates of deposit: available to customers who deposit a minimum amount for fixed terms. They can be held untilmaturity or sold in the CD market.

14

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances June 2008 Marking Scheme

Marks1 (a) Cash budget

Ticket sales 2Other sales 1Costs re ‘other sales’ 1Leading lady’s salary 1Other cast members 1Musicians 1Production company staff 1Production company fee 1Production equipment 1Costumes 1Background 0·5Theatre hire 1Equipment costs 1Depreciation – ignore 1Ticket agent’s commission 2Net cash flow 0·5Opening balance b/f 0·5Closing balance c/f 0·5

–––18

–––

(b) Sensitivity analysisEach valid point 1

–––6

–––

(c) NPVSaved production costs 0·5Saved admin fees 0·5Saved equipment costs 0·5Legal costs 0·5Registration costs 0·5Equipment 0·5Maintenance costs 0·5Lost revenue 2Salaries 0·5Professional fees 0·5Depreciation – ignore 0·5Net cash flow 0·5Discount factors/annuity factor 0·5Use of annuity factor 0·5Discounted cash flow 0·5Follow-on NPV 0·5Conclusion 0·5Presentation 0·5

–––Maximum marks 10

–––

(d) (i) Payback explained–––

Explanation 2–––

(ii) DifferencesEach difference 1

–––Max marks 2

–––

(iii) Advantages–––

Each advantage 1–––

2–––

Overall total 40–––

15

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–––Marks

2 (a) Calculation 2Explanation 2

–––4

–––

(b) Simple/compound interestEach point explained 1

–––Max marks 4

–––

(c) Whether to factorNew sales level 1New receivables level 1Current cost 1Receivables at 70 days 1Cost of 80% advanced 2Cost of 20% not advanced 2Admin fee 1Saved salary 1Factor cost 1Conclusion 1

–––12

–––Overall total 20

––––––

3 (a) Overtrading–––

Explanation 2–––

(b) SymptomsTurnover 1Current assets 1Fixed assets 1Liquidity ratios 1Debt ratios 1Trade payables 1Bank overdraft 1

–––Max marks 5

–––

(c) DiscussionEach point discussed 1

–––Max marks 5

–––

(d) Inventory calculations–––

(i) Re-order level 3––––––

(ii) EOQ calculation 2––––––

(iii) Maximum level 3–––

Overall total 20––––––

16

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Marks4 (a) Retail/wholesale banks

Retail banks 2Wholesale banks 2

–––4

–––

(b) Functions of central bankEach function described 2

–––Max marks 8

–––

(c) Money marketsShort-term 0·5Wholesale amounts 0·5Cover shortages 0·5Facilitate use of surpluses 0·5Primary market 0·5Secondary market 0·5Interbank market 0·5Eurocurrency market 0·5Certificates of deposit market 0·5Intercompany market 0·5Local authority market 0·5Any reasonable point 0·5/1

–––––Max marks 4

–––––

(d) Money market instrumentsDeposits 1Bills 1Commercial papers 1Certificates of deposit 1–––––

4–––––Overall total 20––––––––––

17

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Certified Accounting Technician ExaminationAdvanced Level

Time allowedReading and planning: 15 minutesWriting: 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor.

During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet untilinstructed by the supervisor.

This question paper must not be removed from the examination hall.

Pape

r T1

0

Managing Finances

Wednesday 10 December 2008

The Association of Chartered Certified Accountants

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ALL FOUR questions are compulsory and MUST be attempted

1 Wicker Co manufactures chairs. It has recently been approached by one of its customers, Chill Co, a garden furnitureretailer, who has asked it to enter into a five-year contract to supply a particular range of chairs. The chairs will formpart of Chill Co’s new luxury collection that they plan to start selling in three months’ time. Production would thereforehave to commence as soon as possible.

There are three types of chairs in the collection – The Recliner (R), The Soother (S) and The Handy (H). Wicker Cohas collated the following information:

1 Chill Co estimates that it would purchase the following quantities of R, S and H over the five year period:

Year 1 Year 2 Year 3 Year 4 Year 5R 20,000 22,000 24,200 26,620 29,282S 25,000 27,500 30,250 33,275 36,603H 30,000 33,000 36,300 39,930 43,923

Wicker Co’s intention is not to hold any finished goods inventory at the end of each year.

2 Chill Co will pay $200 for each R purchased, $100 for each S and $70 for each H.

3 Wicker Co will need to use a high-tech machine to make the chairs. This could be purchased immediately at acost of $200,000 and would have no scrap value at the end of the five years. Alternatively, Wicker Co hasanother machine on site, for which it no longer has any use, which could be modified at an immediate cost of$75,000. This machine would then be equivalent to the high-tech machine in terms of its capacity to makechairs. This machine was bought two years ago at a cost of $300,000. If it is not used for the Chill Co contract,it will be sold immediately for $100,000. If modified, it would have no scrap value at the end of the five years.

4 Wicker Co would also use some additional existing machinery to carry out the work on the chairs. Depreciationof $45,000 per annum would be allocated to this contract.

5 Materials usage for each of the three chairs are as follows:

R S HWood X (m2) 1 2 3Fabric (m) 3 2 1

6 Materials costs are as follows:Wood X $14 per m2

Fabric $22 per m

Wicker Co already has 160,000m2 of wood X in inventory, which it ordered in error last month. Wood X cost$20 per m2. If Wicker does not use wood X for this contract, it will either be used immediately as a substitutefor Wood Y, which currently costs $13 per m2, or sold for $11 per m2.

Also, Wicker Co already has 294,000m of fabric in inventory. The fabric cost the company $20 per metre. If itdoes not use this fabric for the Chill Co contract, the fabric would be sold immediately for $10 per metre sinceit has no other use for it.

7 Each chair requires the following amount of time from Wicker Co’s skilled and unskilled labour forces:

R S HSkilled (hours) 2 2 2Unskilled (hours) 1 1 1

At present, the company’s skilled labour force costs $8 per hour and its unskilled labour force costs $6 per hour.The company’s skilled labour force is working to full capacity, so new staff will need to be recruited if the ChillCo contract is entered into. These will cost $9 per hour and will be needed for the whole period of the contract.However, there is an unexpected surplus capacity of unskilled labour for the first year. It is thought that existingemployees can provide 35,000 of the unskilled labour hours required in the first year, at no extra cost to thecompany. The remainder of the unskilled hours required will be provided by the employment of additional staffat $6 per hour.

8 Variable overheads will be incurred at the rate of $4 per skilled and unskilled labour hour used.

2

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9 Fixed overheads are expected to be $400,000 per annum. Of these, $220,000 relates to apportionment offactory rent. The factory space that would be used for the contract is currently unused and Wicker Co does notforesee it being used at all in the future unless this contract is entered into. The remainder of the fixed overheadcost relates to a new warehouse that would be rented to cope with the increased storage space required for theChill Co contract.

10 The company’s cost of capital is 11·5%.

Required:

(a) Within the context of relevant costing, explain how to determine the relevant cost of the following items forthe Chill Co contract:

(i) machine costs (note 3)(ii) wood costs (note 6)(iii) fabric costs (note 6)

Note: whilst you should explain the correct costs to be used, detailed calculations should be performed in (b)below. (8 marks)

(b) Using the discount factors provided below, calculate the net present value of the contract and recommendwhether Wicker Co should enter into the contract. Workings should be in $’000, to the nearest $’000.

Discount factors

Time Factor11·5%

1 0·8972 0·8043 0·7214 0·6475 0·580

(32 marks)

(40 marks)

3 [P.T.O.

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2 Brush Co is a recently established company specialising in the manufacture of a range of drugs for the pharmaceuticalindustry. Two brothers, Thomas and Gerald Broom, formed the company and have just finished the first year ofbusiness. Sales are made to customers on 60-day payment terms and all suppliers offer 30 days’ credit. All of theraw materials purchased by Brush Co only last for a limited time. Therefore, it is the company’s policy that suchchemicals are used within 75 days of purchase.

Whilst the brothers are experienced in the field of pharmaceuticals, they are finding it difficult to understand some ofthe financial matters associated with running a company.

You are employed in the company as an accounting technician and have collated the following information for the lastyear.

$Sales 1,500,000

Raw material purchases 378,000Direct labour costs 240,000Variable production overheads 215,000Apportioned fixed production overheads 185,000

Average receivables 356,000

Average inventories:Finished goods 210,000Work-in-progress (WIP) 58,000Raw materials 82,000

Average payables:Materials 45,000Variable and fixed overheads 75,000Direct labour 9,000

Other relevant information1 All finished goods inventory and WIP values include raw materials, direct labour, variable production overheads

and apportioned fixed production overhead costs. 2 Assume WIP is 70% complete.3 Assume there are 365 days in one year.4 Assume that production and sales volumes are the same.5 The length of the average working capital cycle in this type of business is 90 days.

Required:

(a) Calculate Brush Co’s working capital cycle (cash operating cycle) in days. All workings should be rounded tothe nearest complete day. (10 marks)

(b) Explain what working capital management is and why it is important. (4 marks)

(c) From your calculations in part (a), identify possible concerns that Brush Co’s chief accountant may haveabout the company’s working capital cycle. (6 marks)

(20 marks)

4

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This is a blank page.Question 3 begins on page 6.

5 [P.T.O.

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3 Print Co is a printing company providing a range of printing services to commercial businesses and the public (non-commercial customers.) It has three main suppliers, which it uses for the majority of its supplies, but also uses anumber of smaller suppliers for its sundry purchases. Whilst commercial customers are sometimes provided with acredit facility, non-commercial customers must pay on the day with cash, cheque, debit or credit card. Print Coprepares cleared funds forecasts on a weekly basis.

You are an accounting technician for the company and have been asked to prepare a cleared funds forecast for theperiod Monday 19 January to Friday 23 January 2009 inclusive. You have been provided with the followinginformation:

1 Receipts Commercial customers Month to:Customer Credit terms Payment 19 Jan. 19 Dec. 19 Nov.name method 2009 sales 2008 sales 2008 salesAnchor Co 2 calendar months Cheque $18,000 $24,000 $16,000Beauty Co 1 calendar month Cheque $13,000 $18,000 $17,000Kent Co 1 calendar month BACS $20,000 $18,000 $15,000Hut Co None Cash $2,200 $5,400 –Light Co None Cheque $4,500 – $2,200

Non-commercial customersPayment Mon Tue Wed Thu Fri Mon Tue Wed Thu Frimethod 12 13 14 15 16 19 20 21 22 23

Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan.Cash $300 $230 – $120 – – $220 $350 – $430Cheque $220 – – – – – – – – –Debit card $255 $426 – – – $170 $210 – – –Credit card – – – – – – – – – $3,500

Notes(i) Receipt of money by BACS is instantaneous.(ii) All commercial customers are reliable, as cheques are always received on 19th day of each month. They

are banked on the same day and clear on the fourth working day following the date of receipt.(iii) Debit card payments are credited to Print Co’s account on the next working day following the date of sale.

They represent cleared funds as soon as they are credited.(iv) Credit card receipts clear in Print Co’s bank account on the fifth working day following the day of sale.(v) A ‘working day’ is a Monday, Tuesday, Wednesday, Thursday or Friday.

2 Payments to suppliersMain suppliersSupplier name Credit terms Payment Jan. 2009 Dec. 2008 Nov. 2008

method purchases purchases purchasesInk Co 1 month Direct debit $6,500 $5,500 $4,200Toner Co 2 months Direct debit $8,500 $8,000 $10,600Paper Co 1 month Direct debit $7,200 $10,500 $5,400

Notes(i) Print Co’s monthly direct debit payments will leave its account on 23 January. (ii) Print Co pays its sundry suppliers by cheque each month. These total $8,200 for January and will also be

sent out on 23 January.

3 Wages and salariesAll staff are paid a monthly salary by BACS on the 22nd day of each month. The total salaries cost for Januaryis $9,600. BACS transactions are initiated and paid on the same day.

4 Other paymentsEvery Monday morning, the cashier withdraws $150 from the company bank account to use as petty cash. Themoney leaves Print Co’s bank account straight away.

6

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5 Other informationThe balance on Print Co’s bank account will be $35,000 on 19 January 2009. This represents both the bookbalance and cleared funds.

Required:

Prepare a cleared funds forecast for the period Monday 19 January to Friday 23 January 2009 inclusive usingthe information provided. Show clearly the uncleared funds float and the total book balance carried forward eachday.

(20 marks)

4 Slim Jim Co is a five-year old private company specialising in the manufacture of a range of health drinks, foods andsupplements aimed at the fitness market. At present, their biggest customers are health food shops and fitnesscentres. However, now that their brand has become established, the wealthy owners, who also manage the business,are convinced that sales could be increased dramatically through the opening of an internet shop. They are currentlyconsidering how best to fund the expansion of the business.

Funds would be needed to set up the website, expand manufacturing at the factory, and employ more staff to dealwith administration, despatch and delivery of the web orders.

It is estimated that $2 million would be needed for the expansion. At present, the market value of the company’sequity is $4 million and the company has loans of $0·5 million, repayable in six months time. The company also hascash built up from retained earnings of $1·3 million.

Required:

(a) Outline THREE appropriate sources of medium/long-term finance that may be available to Slim Jim Co tofinance its expansion. (Presume that government grants and leasing are NOT appropriate.) (5 marks)

(b) Discuss FIVE factors that Slim Jim Co should take into account when deciding on the mix of debt and equityfinance. (15 marks)

(20 marks)

End of Question Paper

7

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2008 Answers

1 Wicker Co

(a) Relevant costs

Machine costsThere are two alternatives to consider for the machine. The first is the purchase of the new machine for $200,000. This costhas to be compared to the cost of not purchasing the new machine but instead, converting the old one. The total cost of thislatter option would be the conversion cost of $75,000 together with the lost sale proceeds of $100,000. The $75,000 isrelevant to the decision since it is an incremental cash flow if this option is chosen. The $100,000 is also relevant since itis the opportunity cost of keeping the old machine. If it is kept, it cannot be sold and these potential sales proceeds aretherefore lost. Hence, the total costs of $175,000 ($100,000 + $75,000) must be compared to the cost of buying a newmachine, which is $200,000. The assumption is then made within relevant costing that the company chooses the cheaperoption which, in this case, is keeping the old machine and converting it. Hence, it is the $175,000 that is relevant to theNPV calculation.

Wood XIn deciding the relevant cost for wood X, Wicker Co has to firstly decide what it would do with wood X if it did not use it forthis contract. It has two choices – either sell wood X for $11 per metre or use it as a substitute for wood Y, saving $13 permetre. The best of these alternatives is to use it as a substitute for wood Y, saving $13 per metre. Next, Wicker Co shouldcompare the value of wood X as a substitute ($13 per m) to the cost of buying new wood for the Chill Co contract ($14 perm). It is clearly better to use the wood for this contract. Therefore, the opportunity cost for wood X is $13 per m2, at T0. $13 x 160,000 = $2·08 million.

From T2 onwards, the replacement cost of $14 per metre is the relevant cost. At no point is the $20 historic cost of wood Xrelevant since it is a sunk cost.

Fabric costsWith regards to fabric, Wicker Co has two choices: either sell the fabric for $10 per metre or use it for the Chill Co contract.Since the current cost of the fabric is $22 per metre, Wicker Co should use the fabric rather than selling it. The cost is thereforethe lost sale proceeds of 294,000 x $10. These lost sales proceeds of $2·94m are all included at T0 since, if it were not tobe used for this contract, the fabric would be sold immediately.

(b) Net present valueT0 T1 T2 T3 T4 T5

$’000 $’000 $’000 $’000 $’000 $’000Sales (W1) 8,600 9,460 10,406 11,447 12,591Machine modification (175)Depreciation – ignoreWood (W2) (2,080) – (2,464) (2,710) (2,981) (3,280)Fabric (W3) (2,940) – – (3,727) (4,099) (4,509)Skilled labour (W4) (1,350) (1,485) (1,634) (1,797) (1,977)Unskilled labour (W5) (240) (495) (545) (599) (659)Variable overheads (W6) (900) (990) (1,089) (1,198) (1,318)Fixed overheads (180) (180) (180) (180) (180)

––––––– –––––– ––––––– ––––––– –––––– –––––––Net cash flows (5,195) 5,930 3,846 521 593 668

––––––– –––––– ––––––– ––––––– –––––– –––––––Discount factors 1 0·897 0·804 0·721 0·647 0·580

––––––– –––––– ––––––– ––––––– –––––– –––––––Present value (5,195) 5,319 3,092 376 384 387

––––––– –––––– ––––––– ––––––– –––––– –––––––––––––– –––––– ––––––– ––––––– –––––– –––––––

The net present value of the contract is $4·363m. Since the net present value is positive, the contract should be entered into.

WorkingsW1: Sales T0 T1 T2 T3 T4 T5Annual sales levels per questionR: 20,000 22,000 24,200 26,620 29,282S: 25,000 27,500 30,250 33,275 36,603H: 30,000 33,000 36,300 39,930 43,923

––––––– ––––––– ––––––– ––––––– –––––––Total sales levels 75,000 82,500 90,750 99,825 109,808

––––––– ––––––– ––––––– ––––––– –––––––

Sales revenue $’000 $’000 $’000 $’000 $’000R: at $200 each 4,000 4,400 4,840 5,324 5,856S: at $100 each 2,500 2,750 3,025 3,328 3,660H: at $70 each 2,100 2,310 2,541 2,795 3,075

––––––– ––––––– ––––––– ––––––– –––––––Total sales 8,600 9,460 10,406 11,447 12,591

––––––– ––––––– ––––––– ––––––– –––––––

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Page 169: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

W2: Wood T0 T1 T2 T3 T4 T5R: annual sales level x 1m2 20,000 22,000 24,200 26,620 29,282S: annual sales level x 2m2 50,000 55,000 60,500 66,550 73,206H: annual sales level x 3m2 90,000 99,000 108,900 119,790 131,769

–––––––– –––––––– –––––––– –––––––– ––––––––Total m required per annum. 160,000 176,000 193,600 212,960 234,257

–––––––– –––––––– –––––––– –––––––– ––––––––

$’000 $’000 $’000 $’000 $’000 $’000Total cost at $13 per m2 (T0) & 2,080 – 2,464 2,710 2,981 3,280

––––––– –––––––– –––––––– –––––––– –––––––– ––––––––$14 per m2 at T3 to 5.

W3: FabricR: annual sales level x 3m 60,000 66,000 72,600 79,860 87,846S: annual sales level x 2m 50,000 55,000 60,500 66,550 73,206H: annual sales level x 1m 30,000 33,000 36,300 39,930 43,923

–––––––– –––––––– –––––––– –––––––– ––––––––Total m required per annum 140,000 154,000 169,400 186,340 204,975Less: already in inventory –140,000 –154,000 0 0 0

–––––––– –––––––– –––––––– –––––––– ––––––––Purchase requirements 0 0 169,400 186,340 204,975

–––––––– –––––––– –––––––– –––––––– ––––––––

$’000 $’000 $’000 $’000 $’000 $’000Total cost at $10 for T0 2,940 – – 3,727 4,099 4,509

––––––– –––––––– –––––––– –––––––– –––––––– ––––––––& T2/$22 T3–5

W4: Skilled labourTotal sales levels 75,000 82,500 90,750 99,825 109,808

$’000 $’000 $’000 $’000 $’000x 2 hours each, at $9 per hour. 1,350 1,485 1,634 1,797 1,977

–––––––– –––––––– –––––––– –––––––– ––––––––

W5: Unskilled labourTotal sales levels and hours required 75,000 82,500 90,750 99,825 109,808Less: available unused hours –35,000 – – – –

–––––––– –––––––– –––––––– –––––––– ––––––––Hours required 40,000 82,500 90,750 99,825 109,808

–––––––– –––––––– –––––––– –––––––– ––––––––

$’000 $’000 $’000 $’000 $’000Total cost at $6 per hour 240 495 545 599 659

–––––––– –––––––– –––––––– –––––––– ––––––––

W6: Variable overheadsTotal sales levels 75,000 82,500 90,750 99,825 109,808Hours required per unit 3 3 3 3 3

–––––––– –––––––– –––––––– –––––––– ––––––––Total hours required 225,000 247,500 272,250 299,475 329,424

–––––––– –––––––– –––––––– –––––––– ––––––––

$’000 $’000 $’000 $’000 $’000Total cost at $4 per hour 900 990 1,089 1,198 1,318

–––––––– –––––––– –––––––– –––––––– ––––––––

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Page 170: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

2 Brush Co

(a) Working capital cycle

Inventories: $ DaysRaw materials: Raw materials 82,000–––––––––––– x 365 = –––––––––– x 365 79Purchases 378,000

Work in progress:Work in progress 58,000––––––––––––––––––––––––––––––––––– x 365 = ––––––––––––––––– x 365 30Cost of sales (w.1) x degree of completion 1,018,000 x 70%

Finished goods:Finished goods 210,000––––––––––––– x 365 = –––––––––– x 365 75Cost of sales 1,018,000

Credit allowed to customers:Receivables 356,000–––––––––– x 365 = –––––––––– x 365 87Sales 1,500,000

Credit taken from suppliers:Materials:Payables 45,000–––––––––––––––– x 365 = ––––––––– x 365 (43)Raw materials costs 378,000

Overheads:Payables 75,000–––––––––––––––––––– x 365 = ––––––––– x 365 (68)Variable/fixed overheads 400,000

Labour:Payables 9,000––––––––––––––– x 365 = –––––––– x 365 (14)Direct labour costs 240,000

––––146––––––––

Working 1: Cost of sales $Raw material costs 378,000Direct labour 240,000Variable production overheads 215,000Apportioned fixed production overheads 185,000

––––––––––1,018,000––––––––––––––––––––

(b) Working capital management

Working capital management involves:– controlling the overall liquidity position of a business, and– controlling the individual elements of working capital, namely inventories, receivables, cash and payables.

The aim of working capital management is to balance having too much working capital with having too little working capital.Too much working capital is costly in terms of lost opportunities and finance charges for cash tied up; too little working capitalcan lead to the inability to pay debts as they fall due, or necessitate the use of expensive short-term borrowing. It is thereforeimportant to manage it effectively.

(c) Concerns about Brush Co’s working capital cycle

– The receivables payment period is 87 days. This is too long, given that Brush Co only allows 60 days credit tocustomers. Also, it is twice as long as the payment period for raw material supplies and overheads.

– The payment period for raw material supplies is 43 days and for overheads it is much higher, at 68 days. These periodsare both longer than the agreed credit period of 30 days. This could lead to interest being charged by suppliers and adeterioration in the relationships with suppliers.

– Raw materials are held for an average of 79 days. Since it is the company’s policy to use raw materials within 75 daysof purchase, these inventories are too high. The company’s policy is being breached, which could lead to substandarddrugs being manufactured.

– Overall, the working capital cycle is too long. At 146 days, it is 56 days longer than comparative companies. This iscosting the company money in terms of cash tied up in working capital and lost opportunities elsewhere.

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Page 171: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

3 Print Co

Cleared Funds Forecast19 Jan 20 Jan 21 Jan 22 Jan 23 Jan

$ $ $ $ $Receipts (w 1)Anchor Co 16,000Beauty Co 18,000Kent Co 18,000Hut Co 2,200Light Co 4,500Non-commercial customers – method:Cash 220 350 430Debit card 170 210Credit card

––––––– ––––––– ––––––– ––––––– –––––––20,200 390 560 0 38,930––––––– ––––––– ––––––– ––––––– –––––––

PaymentsInk Co 5,500Toner Co 10,600Paper Co 10,500Other cheques Salaries 9,600Petty cash 150

––––––– ––––––– ––––––– ––––––– –––––––150 0 0 9,600 26,600

––––––– ––––––– ––––––– ––––––– –––––––

Cleared excess receiptsover payments 20,050 390 560 (9,600) 12,330Cleared balance b/f 35,000 55,050 55,440 56,000 46,400

––––––– ––––––– ––––––– ––––––– –––––––Cleared balance c/f 55,050 55,440 56,000 46,400 58,730

––––––– ––––––– ––––––– ––––––– –––––––

Uncleared funds floatReceipts 38,670 38,710 38,500 38,500 3,500Payments (8,200)

––––––– ––––––– ––––––– ––––––– –––––––38,670 38,710 38,500 38,500 (4,700)––––––– ––––––– ––––––– ––––––– –––––––

Total book balance c/f 93,720 94,150 94,500 84,900 54,030––––––– ––––––– ––––––– ––––––– –––––––––––––– ––––––– ––––––– ––––––– –––––––

Working 1Uncleared funds: Receipts $Anchor (Nov. sales) 16,000Beauty Co (Dec. sales) 18,000Light Co (Jan. sales) 4,500Debit (DR) card receipts 19 Jan 170

––––––––Uncleared receipts 19 Jan 38,670

––––––––Less: cleared DR card receipts from 19 Jan –170Add: debit card receipts from 20 Jan 210

––––––––Uncleared receipts 20 Jan 38,710

––––––––Less: cleared DR card receipts 20 Jan –210

––––––––Uncleared receipts 21 and 22 Jan 38,500

––––––––Less: cleared cheques from 19 Jan –38,500Add: uncleared credit card receipts 3,500

––––––––Uncleared receipts 23 Jan 3,500

––––––––––––––––

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Page 172: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

4 Slim Jim Co

(a) Sources of finance

(i) Retained earningsThis is the most obvious source of finance for at least part of the funds required. Slim Jim could use part of the $1·3 million for the investment. However, given that the loan is repayable in six months time, the company must keep$0·5 million back for this. Also, there are often cost overruns on this sort of project so Slim Jim must keep some retainedearnings back to cover these.

(ii) LoanSlim Jim Co could take out a loan from the bank. It is unlikely to have access to any other source of debt provider (suchas the international bond market) since it is not a large company.

(iii) Rights issue of sharesPresumably, since we know that Slim Jim’s current owners are ‘wealthy’, they could inject more cash into the companyin the form of shares. This will prevent any dilution of control by selling shares outside of the company.

(iv) New share issueThis would have to be to private investors, unless the company were to be floated on the stock exchange.

(v) Venture capitalSlim Jim could approach a venture capital company with a view to obtaining funds for the expansion of the business.However, venture capitalists would want to be closely involved with the new venture, even expecting a place on theboard of directors.

(b) Mix of debt and equity

Factors that should be taken into account are as follows:

(i) CostThe cost of equity is higher than the cost of debt. This is because an equity investor takes a greater risk. If the companygoes into liquidation, an equity investor is the last person to be paid any money. Therefore, an equity investor expectsa higher return to reflect the risk he is taking. Also, whereas equity holders receive their return in the form of dividends,lenders receive interest. Whilst interest payments are deductible for tax purposes, dividends are not. This makes the costof paying $100 in interest, for example, less than the cost of paying $100 in the form of dividends.

The tax relief element, combined with the lower risk element of debt, means that debt finance will definitely be cheaper.

(ii) Control of the businessEquity is normally injected into the business through the issue of ordinary shares. These allow the holder to share in theownership of the business and carry voting rights. Hence, a shareholder can participate in business decisions. Themarket value of Slim Jim Co’s shares is currently $4 million. If the company issues a further $2 million of shares toprivate investors, then one would expect the investors to gain about 1/3 of the total number of shares in issue (2:4).This would give them a large degree of control over company decisions. Many resolutions of a company require 75%of the votes and Slim Co would therefore be advised to think carefully before issuing shares giving new shareholders thisdegree of control.

(iii) Current level of debt and maturity of existing borrowingsA significant difference between debt and equity is that debt has to be repaid, whereas equity does not. It is thereforeessential to review the level of Slim Jim’s current debt and the time period over which it has to be repaid. At present,the company has $0·5 million of loans to be repaid over the next six months. Cash flow and profit forecasts would needto be prepared in order to decide whether the company could undertake another loan at this point in time. There is notenough information here to decide.

(iv) Effect on gearingGearing can be calculated in many ways but, in simple terms, it measures the amount of debt against the amount ofequity in a company. If debt is increased too much relative to equity, potential lenders will then see Slim Jim Co as ahigh risk investment. They will then expect better returns to reflect their increased level of risk. At worst, they will refuseto lend at all. Since Slim Jim Co has $4 million of equity and only has loans outstanding of $0·5 million (which willhave been repaid in six months anyway), gearing will increase substantially if the company issues $2 million of loans.However, given the maturity of existing borrowings in six months, even with a full $2 million of loans, the company isunlikely to be seen as so risky that a lender would not grant a loan. This assumes, of course, that the company can paythe existing borrowings in six months without having to refinance them.

(v) Availability of financeSlim Jim Co is a private company. This means that it cannot sell shares to the general public. Equity finance must comefrom private investors. As such, the mix of debt and equity finance is restricted by the company’s ability to attract privateinvestors. It is probably going to be much easier for Slim Jim to obtain debt, rather than equity, finance. This ispresuming the company can offer some form of security for the loan. Debt finance would be restricted if this was notthe case, since the lender would view the debt as more high risk without security.

As regards equity finance, the company could consider floating its shares on the stock exchange in order to gain accessto a greater pool of investors.

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Page 173: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

ACCA Certified Accounting Technician Examination – Paper T10Managing Finances December 2008 Marking Scheme

Marks1 (a) Costs explained

One mark per valid point 1–––

Max. marks 8–––

(b) NPVSales 6Depreciation ignored 1Machine – incl. f £100k 1Machine – incl. £75k 1Wood – 1 mark per year 5Fabric – one mark per year 5Skilled labour 2Unskilled labour T1 2Unskilled labour T2–5 2Variable overheads 1Fixed overheads – ignoring £220k 1Fixed overheads – including £180k 1Net cash flow 1Present values 1Net present value 1Conclusion 1

–––32

––––––

Total marks 40––––––

2 (a) Working capital cycleRaw materials period 1Finished goods period 1WIP period 2Receivables period 1Payables period (mats) 1Payables period (o/heads) 1Payables period (labour) 1COS working 1Total cycle 1

–––10

–––

(b) Working capital managementExplanation of WCM 2Why it is important 2

–––4

–––

(c) ConcernsEach one identified & explained 2

–––Max. 6

––––––

Total marks 20––––––

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Page 174: 15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

18

Marks3 Receipts:

Anchor Co 0·5Beauty Co 0·5Kent Co 0·5Hut Co 0·5Light Co 0·5Non-comm. cash customers 1Non-comm. DR card customers 1Total receipts 1Payments:Ink Co 0·5Toner Co 0·5Paper Co 0·5Salaries 1Petty cash 1Total payments 1Cleared excess Rs over Ps 1Cleared balance b/f 1Cleared balance c/f 1Uncleared funds floatUncleared receipts – 19 Jan 2Uncleared receipts – 20 Jan 1Uncleared receipts – 21 & 22 Jan 1Uncleared receipts – 23 Jan 1Uncleared payments – 23 Jan 1Total book balance c/f 1

–––Total marks 20

––––––

4 (a) Sources of financeMax. marks for each source 2

–––Max. overall 5

–––

(b) Mix of debt and equityCost 3Control of the business 3Current level of debt & maturity 3Effect on gearing 3Availability of finance 3

–––15

––––––

Total marks 20––––––

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